Q2 2022 Graco Inc Earnings Call

July 28, 2022

Okay.

Good morning, and welcome to the second quarter Conference call for Graco, Inc. If.

If you wish to access the replay for this call you may do so by visiting the Companys website at Www Dot great go Dot com.

Gregg go has additional information available in a Powerpoint slide 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 the opening remarks from management.

During this call various 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 of the company's 2021 annual report on Form 10-K and in item one a of the company's most recent quarterly report on Form 10-Q.

These reports are available on the company's website at Www Dot Graco Dot com and the SEC's website at Www Dot S E C Dot Gov.

Forward looking 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 John Locke Executive Vice President corporate controller and information systems. Please go ahead.

Good morning, everyone and thank you for joining our call I'm here today with Mark Sharon and David Though I will provide a brief overview of our quarterly results before turning the call over to Mark for additional discussion.

Our conference call slides and our second quarter Form 10-Q or on our website provides additional information on our quarter.

Yesterday, we reported second quarter sales of $549 million, an increase of 8% from the second quarter of last year.

Reported net earnings were $117 million for the quarter or <unk> 68 cents per diluted share.

The effect of currency translation rates.

So headwind in the quarter on both sales and earnings decreasing sales by 4% or $15 million and decreasing that earnings by 8% or $7 million we.

We expect translation rate to continue to be a challenge for the remainder of the year.

At current exchange rates, we expect the full year unfavorable effect of currency translation to decrease sales by 3% and earnings by 7% with the impact in the second half being similar to what was experienced in the second quarter.

The gross margin rate was down 300 basis points from the second quarter of last year and down 250 basis points from the first quarter.

During the quarter material cost accelerated from the already elevated levels of the previous year.

Our beginning of the year pricing actions were not enough to offset the impact of these additional costs on the gross margin rate.

Given the cost increases we are experiencing we are implementing interim price increases across all segments and regions.

These pricing actions will begin to take effect throughout the third quarter.

At current cost and volume, we expect that our 2022 pricing actions will offset the input cost pressures on a dollar basis.

Of course, the cost of many commodities remain volatile and we will be closely monitored.

Operating expenses decreased $10 million or 7% in the quarter.

Sales and volume based expenses decreased $6 million against the high comparable in the second quarter of last year.

Currency translation rate also decreased operating expenses by $3 million.

The adjusted tax rate for the quarter was 20% due to the unfavorable effects of foreign earnings taxed at higher rates than the U S right.

We anticipate this trend will likely continue and expect our estimated annual tax rate will be 19% to 20%.

Cash flow from operations or $135 million for the year, a decrease of $85 million from last year, mostly driven by annual incentive payments made in the first quarter and increased inventory purchases to meet demand.

For the year to date, we have repurchased one 7 million shares for $120 million, which will more than eliminate dilution in 2022.

We also prepaid $75 million of our private placement debt.

Capital expenditures of $89 million with $48 million related to facility expansion projects.

And had dividend payments of $71 million.

Finally, our full year estimate for unallocated corporate expense and capital expenditures can be found in the conference call slide deck on page 10.

Turn the call over to Mark now for further discussion.

Kathy and good morning, everyone. All of my comments. This morning will be on an organic constant currency basis.

We had a good second quarter with record sales in all reportable segments industrial and process experienced broad based double digit sales growth in all regions.

In contractor North America remained positive, but EMEA and Asia Pacific saw declines in the quarter.

Sales to Russia, and the extended China shutdown contributed to the modest declines.

Product availability remained challenging and contractor due to component shortages and labor constraints at our suppliers.

Our consolidated backlog was $430 million at the end of the quarter, which is $65 million higher than at the end of last year and $190 million higher than the same period a year ago.

While we are still experiencing regular supply disruptions weekly material receipts have increased since the beginning of the year with nine of our top 10 suppliers either improving their out the door performance or remaining consistent.

The electronic components.

Board assemblies electric motors gas engine and certain castings remained bottlenecks.

Despite these challenges factory output was strong resulting in a $15 million decline in backlog from the end of the first quarter.

Since 2018, we have invested $425 million to expand our global manufacturing capacity.

This expansion has allowed us to support higher demand with increased output by nearly 30% during the same period.

These investments combined with improving component availability gives us confidence that we will be able to deliver enough products to reach our 2022 revenue outlook.

One more thing before commenting on our segments.

Since commodity prices and component costs have continued to rise we will be implementing another round of price increases starting this <unk>.

While we recognize the cadence is different than what we've done historically our actions are not isolated given the current operating environment.

We anticipate resuming our normal pricing cadence at the beginning of next year.

Now turning to some commentary on our segments.

After a very long strong second quarter last year and following several years of record growth. The contractor segment was up low single digits for the quarter.

Ongoing component shortages in this segment have resulted in delayed shipments to customers in all regions.

Incoming order rates have slowed in an environment of rising mortgage rates and lower home sales.

However, contractors remain busy and forecasts for our commercial construction and remodeling activity remain positive.

In addition.

We still have an elevated backlog of their $95 million, which is up 10% since the end of last year and is nearly double the same period a year ago.

Profitability improved sequentially in the quarter due to lower expenses and earlier pricing actions.

The industrial segment posted its sixth consecutive quarter of double digit growth.

The segment grew in all reportable regions and achieved second quarter records for sales and operating earnings resulting in strong incremental margins of 62%.

Despite the impact of the pandemic related shutdowns in China demand remains robust in multiple product categories.

Booking rates in Asia Pacific improved towards the end of the quarter. When these mobility restrictions were largely lifted.

Backlog is up $30 million compared to the end of last year and $60 million compared to the same time a year ago.

The process segment grew sales, 27% for the quarter, resulting in records for both revenue and operating earnings.

<unk> strengthened worldwide demand for lubrication equipment process pumps, environmental and semiconductor products.

Profitability for the quarter was strong despite some negative impacts from cost pressures on key components.

Moving onto our outlook.

Demand in the Americas remains firm in all segments.

Our outlook for EMEA remains cautious due to softening economic conditions and geopolitical uncertainty.

Pandemic related shutdowns in China also affected incoming order rates. However, once these restrictions were lifted we saw orders improved significantly.

With our backlog near record levels, plus the effects of our pricing actions.

We are confirming our 2022 revenue guidance of high single digits on an organic constant currency basis with growth expected in every reportable segment.

In closing I want to thank all of our employees for overcoming the many commercial and operational hurdles. We have seen in this difficult operating environment.

They make major contributions to our markets and customers every day.

Driving to deliver a plus customer service.

That concludes our prepared remarks, operator, we're ready for questions.

Thank you the question and answer session will begin at this time as a reminder to ask a question you will need to press star one one on your telephone.

Questions will be taken in the order that is received please standby for the first question.

Today's first question will come from Deane Dray with RBC capital markets. Please go ahead.

Good morning, everyone.

So can we start with the decision to implement <unk>.

Intra year price increase and I expect that internally you all made a bigger deal out of this or anguished over it.

Yes, the way we look at it from the outside because these are just extraordinary circumstances and I know it maybe legacy.

What is keeping you.

A little bit hesitant not pulling the trigger but it makes perfect sense, but just what was the deciding factor and how because it was always the sales disruption to your channel partners was the reason you held off but.

It makes perfect sense, but how did you reach a decision and then thank you for clarifying you'll be back to the cadence and at year.

In January as well thanks.

Yes, Dan it's Mark So we did get together as a team and there wasn't a whole lot of debate or drama around it we do like to make decisions based on facts and simply put a lot of our input costs accelerated since the beginning of the year and we started to see what we call negative PPV, which is a.

Areas between what we planned our cost to be versus what they are actually coming in at now thats starting to creep into the P&L I would say kind of in the latter half of March months of the first quarter and then as we started to work through the beginning of Q2, it became a little bit more meaningful. So we did meet as a team we looked at the facts.

Really across the board, we are seeing pretty substantial increases in a lot of the major components that we buy as an organization and we recognize that by sharing that being transparent with our customers.

And our distributors that we really had a good case to make to raise prices now versus waiting and so there wasn't much drama everyone participated.

All of the different business segments and all of their different regions are all participating in the pricing actions that we're going to take.

Yes, so far it's been.

Nobody likes a price increase rate, but we haven't really had any major pushback from any of our customers our distributors from what we've done.

Got it well I would suggest distributors don't usually complain that loudly if at all but alright, but thats really good color I. Appreciate it and then just as a follow up for David can.

Can you comment on free cash flow and some of the dynamics, there with higher inventory buffer inventory and software because we're seeing that everywhere and that Youtube buybacks in the quarter.

I'll start with the buyback question, we did most of our buyback activity in the first quarter, but I think in Q2, we bought about 170000 shares at.

We've committed approximately $10 million or about $63 a share in purchase price. So the lion share of the reduction.

The share creep had already been done prior to prior to Q2.

And I would add on that is.

And now on cash flow.

We saw improvement in operating cash flow in Q2 versus Q1, and Youre right. One of the big investment items was the I'd say the ongoing inventory build that we have been committed to as we.

Work through our current environment in some cases in a lot of cases, the inventory levels are elevated because we are waiting for that.

Exotic components at Goldman.

Golden screw.

And as we as we receive those chips as we received those screws and bolts on ratings.

Wood in the normal course of business I expect that inventory level to normalize as the year rolls along.

That's real helpful. Thank you.

Thank you one moment for our next question.

That will come from the line of Saree <unk> with Jefferies. Please go ahead.

Thanks for taking my question, so although 49% gross margins are still relatively good.

Has the lowest level since I believe around 2009 for you guys. So with the new August price increase how are you thinking about gross margins in the second half and into 2023.

Yes, so we had not.

Not only the cost pressures that we've talked about but also the translation rates the currency rates really knocked about it think about 100 basis points off of the gross margin this quarter. So.

That pieces, obviously hard to manage and there is not much we can do and through a long cycle those things tend to even out but when we looked at the pricing actions that we're doing.

Similar to what we did last year from the standpoint, we looked at our PPV, which I referenced before and we made an estimate of what that would look like for the balance of this year than heading into I would say like the first half of next year, and we really set our pricing actions to offset or neutralize that PPV that we that we were.

<unk>.

<unk> card is due costco up from here or do they go down from here or do they stay flat.

Obviously, if you are in the camp that thinks that inflation is going to moderate costs are going to come down a little bit that should be beneficial to our gross margin rate.

But if they stay where they're at.

Even if they go up that would be sort of neutral to the right and maybe slightly.

The negative cost accelerate so that's probably the best answer that I can give you Cathy is nodding her head, but if you have anything to add please do so no I think that sums it up really well I think that I would just add that on a dollar cost basis.

We have we implemented the price increase at the beginning of the year and on a dollar cost basis, I think you touched on it Kathy have kept.

The incremental pricing has offset those costs on a dollar basis. However, as mark touched on in Q2 watching where certain costs were certain prices for key components.

We we concluded that this was the time to make a further adjustment to make certain our to do a to increase the probability that we would continue to offset.

Incremental cost with price on a dollar basis.

Thanks, and then just a follow up on the buyback question. Obviously, you did a little bit of buybacks in the quarter, but you still have a net cash position now given the stock price reductions year to date how are you.

Thinking about repurchases and does it make sense to do anything more sizable with that cash.

Well I think our ill pick a start here.

Sure.

Our strategy over the long haul.

Ben has been and continues to be opportunistic.

I think that.

We look at the we look at the current.

Macroeconomic environment is one where we see opportunities commercially and challenges in the world.

As you know we have a strong.

We have a strong capital position and are in the position to move aggressively when we make the decision to do so.

Yes, I think our priority. This year is really to eliminate the creep, which we've done and then as the go forward, we hope to be able to do that again.

Regular basis, but.

David's right.

We're opportunistic when it comes to the real strategic large buybacks and we're keeping our powder dry right now we'll see what happens.

Is there any talk internally about what's optimal balance sheet should look at.

Internally <unk>.

<unk> balance sheet was that the question.

Yes.

It looks like.

Well, we don't have any targets or specific things that we try to run the business based on but we have a lot of flexibility.

Like that we're obviously in the early stages of trying to deploy in M&A strategy, which hopefully will absorb some of that and also increase our leverage in the process of doing that that's our goal. That's the objective and if we aren't successful. There. Obviously, we can look at share buybacks, but theres no theres, no targets or mandates or anything like that that we're trying to issue.

For when it comes to balance sheet management.

There is I understand the concept of balance sheet optimization.

My own view.

Is that the real test of.

I'll call out.

<unk> financing strategy is how it performs in.

Alternative real world scenarios, and Theres no doubt about it that we want to have the capacity to be opportunistic when the opportunities in the market come along as Mark said we.

Have a.

And M&A program that.

We will willingly.

When we make investments in as we see good business opportunities and.

As you've seen over the last couple of years, we're coming off we.

I should say in the middle of a major capital expenditure program that has already drawn several hundred million dollars investments and were not completed yet so.

Central to our evaluation of financial strategies is we don't want to certainly would not view it as a positive to interrupt any of our.

Our strategic plans.

In the event that.

No.

Underlying business conditions change in the short term, we think that's a mistake.

I appreciate the color thanks for taking my questions.

Thank you one moment for our next question.

That will come from the line of Andrew Buscaglia with Baron Berg Capital markets. Please go ahead.

Hey, good morning, guys.

Alright.

So everything this quarter was.

Excellent everything looks great on the margin front and youre pushing through price increases I just wonder.

I think they are so good right now and we're starting to.

Our concerns around Europe , and broadly recessionary scenarios I'm wondering.

What's their mentality internally and maybe you could help us think through the segments most impacted.

Hi.

The dynamics affecting your businesses or segments that will be behind.

Kind of sort of worst case.

Leo.

Things do deteriorate.

Yes, so again, when we try to like to operate on facts and when you look at what's actually happening I mean, the orders are still coming in business is good we don't want to jump the gun on what may or may not happen.

In terms of a slowdown but.

Certainly if you look at what's going on over in Europe with the geopolitical stuff that's happening over there and just overall forecast for GDP and industrial production being pulled back.

Then when you look at what's happening in the U S with rates going up in housing starts probably likely to come in sales of existing homes are pulling back a little bit those are probably the areas that we're keeping our eye on.

Closest but.

In the meantime, we're not stopping anything from what it is we're trying to do to grow the business here, we're not cutting.

Cutting back on expenses, we are managing the P&L pretty tightly just making sure that we're making smart decisions but.

It's more or less business as usual for us and if things change we can adjust pretty quickly here at graco, we've got.

Good team and we can turn on a dime, if we need to so I feel I feel like as we sit here today as you said things are in pretty good shape, we have a huge backlog in.

Hopefully we were able to put up the kind of numbers that we're targeting here for the year that everyone has got in their models.

And maybe maybe just focusing in on the industrial segment because.

The growth was really strong in it.

This pent up demand of years of kind of.

And our investment going on so.

Yes, I think I believe Europe , the biggest portion of that business, it's pretty impactful.

What are you thinking based on already seeing based out of Europe that.

As it pertains to industrial how do you think that segment.

Segment will move if Europe does funds into a recession here.

Yes, I think Europe is probably the biggest chunk of our I'm sorry, industrial is the biggest chunk of our European business and its nice profitable business for us and if you really were to.

To put it into two different buckets, you've got the traditional Greg old legacy businesses, which are sealant and adhesive business in our liquid finishing businesses.

Typically go through a distribution channel and are sold the integrators and things like that and then you've got our powder equipment business, which is the game of business that we've had.

In our portfolio for 10 years, or so now and Thats a little bit more project based they are a little bit more visibility on backlog and orders and.

Looking across those two segments again.

Not to get too granular, but we factor all of that into our overall equation. When we talk about outlook. So you can maybe have different pockets of different businesses that are either stronger or weaker than others.

And then as a part of that you sort of roll it up and you look at Okay. What do we think is going to happen in the forecast and that that's what gets us to this high single digit growth, including what's going on in Europe Asia, China Asia Pacific everywhere. So it's it's a mixed bag personally I do.

Think that Theres still plenty of project business going on over in Europe , and speaking with the team over there they're optimistic.

They feel like they've got good activity is going on and a lot of our end markets and we really don't see that changing here in the near term and I guess, we'll see what happens.

And I guess Scott Yeah go ahead sorry.

No I just was going to say.

Yeah.

Mark gave a comprehensive answer the way I just would.

Summarize, especially on the industrial side the breadth of demand.

For the for the business for the segment.

The segment continues to impress me, both geographically and served markets.

The.

I guess the.

The margin capability incremental margin.

Length of the business has been.

Has been very solid and it seems to have a good foundation.

Including the realized pricing that we've seen that series of businesses generate and the quality of the backlog around the world, especially in that space and not to get too granular is.

Sure.

Very is very good and very broad.

Mix of products the mix of geographies.

As I think.

Very solid.

Got it okay. Thank you.

Thank you one moment for our next question.

That will come from the line of Connor Lynagh with Morgan Stanley . Please go ahead.

Hi, This is actually Thomas on for for <unk>, sorry for the mix up there.

Maybe just helpful for us to go back to the contractor business.

Could you just kind of frame up maybe end market demand there and how we should think about.

I realize maybe rough buckets here, but demand from remodeling versus new home builds versus can commercial construction, if youre able to just kind of help us think through.

We're aware of the risks would be and the magnitude of those potential risks here.

Yes, so we really don't break out the different groups in terms of.

Do it yourself versus Pearl paint, but what I will say is that we feel pretty good about where the Pearl contractor is right now today.

Generally speaking they have.

Good backlog of business that they are working through.

They're busy.

And they are working on all kinds of different projects, including commercial projects residential projects remodeling projects. So we don't have great visibility like exactly where our sprayers are used on a daily basis, but a good professional painting contractor really serves a fairly broad.

Base of customers and I would characterize.

The market right now is pretty healthy for.

For those people and of course, the pro part of our product line is more profitable than the DIY part of the line.

Wi side is the area, where I think that people are probably more concerned about from the consumer standpoint is the consumer going to hang in there or are they going to pull back.

What's going on with inflation you look at like at the home centers foot traffic is down you guys probably know that but.

That's probably the one area in North America that I would be wanting to keep my eye on and over in the regions again, it's more of a professional product mix. There is some home center in Europe , but for the most part.

Again, similar dynamics, they're busy they got backlog they are working.

Labor is another factor that you should think about because.

Labor is tight and so by using.

Power equipment to do a job versus zero manual labor to job.

Youre more efficient number one but you also have to worry about finding labor in a tight market. So I think we're in pretty good shape, we will see what happens still bullish on that market long term, we're still way under built in terms of houses here in North America, I think something like four five or 5 million units that ultimately will.

We'll get caught up in that.

We think we're in a good spot.

Great. Thanks.

All from me, so I'll pass back alright.

Alright.

Thank you one moment for our next question.

And that will come from the line of Matt Summerville with D. A Davidson. Please go ahead.

Thanks, So David is there any way to quantify the impact of the component shortages had on sales this quarter and do you feel like that impact in Q2 was greater or lesser versus what you would have experienced in Q1, and then I can follow up.

I'll start with that with kind of current state I think it's better that we were able to knock about $15 million off of the.

The backlog here in the quarter.

It feels to me like our our throughput from suppliers is better today than it was even three months ago, we're definitely not out of the woods yet but.

Things are in better shape, it's hard to know exactly how much how much higher the revenue could have been if we had gotten everything in that we wanted on time, but for sure it would have been higher.

You look at just what's happened here.

Since the end of the year, it's about $65 million of additional backlog.

And we were at high levels, when we started the year off so.

For sure we were held back can't give you a number as to how big that would be but hopefully as throughput gets better factories are up and running we've made a lot of investments. We've got a lot of new machine tools and equipment coming in.

Our throughput will be better and we hope to really make a dent in that backlog here throughout the rest of the year.

And then as a follow up is there any way I know in a typical more typical year.

Typically go out and look for 150 to maybe 200 basis points of price as we think about.

The price increase earlier this year, which is obviously I'm sure considerably higher than that and then we fold in what you're putting through in Q3.

How would you want how would you help us try and understand the magnitude of what the two of those might add up to be should we be thinking high single digits low double digits is there a way you can help us out with us.

Yes. The best we can do is give you the outlook and the outlook is high single digit organic constant currency for the year and beyond that really can't help you.

Got it thank you.

Thank you as a reminder, if you would like to ask a question. Please press the star one one key.

One moment for our next question.

And that will come from the line of Walter Liptak with Seaport Global Securities. Please go ahead.

Hi, Thanks, Good morning, guys.

Hey, good morning, just wanted to do a couple of follow ups.

So I think what you were saying about contractors that pro painters are still doing great. There they've got a lot of work to do but the home centers you are seeing.

Lower throughput lower sell through at the home centers is that right.

Well I think that the.

The sort of the data that we hear from our own team and some of the other stuff. That's publish is foot traffic in home centers.

As reported as being lower.

That alright.

Zinc has been.

I think there has been something that has been evident for.

For some for some months.

On the propane side.

Just to underline a couple of Mark's point.

When we talk to our own team as recently as earlier in the week.

The professional contractors they check in with.

Theyre very interested not just in labor savings, which we alluded to but also they are very much even today hiring painters when they can get their when they can recruit additional painters to help them and it suggests a level of activity in that arena.

<unk>.

Going to be pretty good I think for the foreseeable future.

Yes, well I think my comments were more I think the question that was asked was what what are you keeping an eye on what might you want to look at.

What what are you keeping an eye on what might you want to look at where some areas where there could be some weakness then I referenced the fact that that the DIY the low and the consumer.

Home Center traffic those things are things that for us to keep an eye on.

Okay, and just to refresh us how much your sales as home centers I think it is fairly small.

Yes, we don't we don't break that out we do not break that out.

Okay.

And maybe in a similar way.

Contractor.

Well, maybe this one in.

In Europe , you guys do EMEA, but what how much is Europe .

Total graco sales.

Okay.

I mean, David do you have the number.

<unk>, 2025%.

The total photo a total total okay, great and then within contractors are much.

Contract are in euro.

Yes.

It's a nice sizable business.

A single, it's the single largest segment in Europe and it is.

It is I would say large largely a a pro paint as well as protective coatings market, which <unk>.

It gives it some level of presence in eastern Europe .

Including markets.

Markets like Russia, and the Middle East.

Okay, Okay that makes sense alright, thank you very much.

Thank you I'm showing no further questions in the queue. At this time I would now like to turn the conference back over to Mr. Mark Sheahan for any closing remarks.

Okay, well. Thank you for participating in today's call before we conclude I would like to especially thank our manufacturing and purchasing teams here, Greg all for delivering more products this quarter than any other quarter in our company's history Manny.

Also like to just give a quick shout out to there are people in China for their professionalism and dedication during the lockdown that was initially supposed to last five days I think it went more than two months.

Once the restrictions were lifted the team got back in the business.

We got orders and they start to get product out the door and they really responded very quickly.

Very very happy about finally, I'd like to acknowledge the efforts of our team in Europe .

Nobody predicted the force majeure events that have transpired in the last six months. The organization continues to impress us with their dedication and commitment of <unk>.

It's been an extremely challenging time for them and for everyone over there.

That concludes today's call. Thanks for listening and I Hope you have a great day.

Sure.

Ladies and gentlemen, ladies and gentlemen, thank you for Donlin Conference you may now disconnect and have a wonderful day.

The conference will begin shortly to raise your hand during Q&A you can dial one one.

Okay.

Yes.

Okay.

Yes.

Sure.

Okay.

Sure.

Yes.

Okay.

Dan.

[music].

Yes.

[music].

Okay.

[music].

Yes.

Sure.

Yes.

Okay.

Yes.

Okay.

[music].

Okay.

[music].

The conference will begin shortly to raise your hand during Q&A you can dial one one.

Sure.

Yes.

Sure.

Okay.

Yes.

Sure.

Okay.

Yes.

Okay.

Yes.

<unk>.

Okay.

Yes.

Okay.

Yes.

Okay.

[music].

Yes.

Okay.

Yes.

Sure.

Yes.

Sure.

Okay.

Yes.

Okay.

Sure.

Yes.

Sure.

Okay.

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

Yeah.

Yes.

[music].

Okay.

Yes.

Okay.

Sure.

Okay.

Sure.

Okay.

Yes.

Okay.

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Okay.

Yeah.

Okay.

Sure.

Okay.

[music].

Yes.

[music].

Okay.

Yes.

Okay.

Yes.

Sure.

Okay.

Yes.

Okay.

Yes.

Okay.

[music].

Okay.

<unk>.

Okay.

[music].

Great.

Okay.

Yes.

Please.

Okay.

Yes.

Okay.

Sure.

Yes.

Okay.

Yes.

Great.

Okay.

Yes.

Okay.

Yes.

Chris.

Yes.

Okay.

Sure.

Okay.

Yes.

Okay.

Yes.

Okay.

Thank you.

Okay.

Yes.

Sure.

Thank you.

Yes.

Okay.

Sure.

Yes.

Okay.

Yes.

Right.

Yes.

Okay.

Sure.

Okay.

Yes.

Okay.

Yes.

Okay.

Thank you.

[music].

Okay.

[music].

Okay.

Thank you.

Sure.

Okay.

Sure.

Okay.

Yes.

Sure.

Yes.

Okay.

Yes.

Sure.

[music].

Okay.

Yes.

Okay.

Sure.

Yes.

Thank you.

Yes.

Yeah.

Okay.

Sure.

Yes.

Sure.

Okay.

Yes.

[music].

Yes.

Okay.

Yes.

Okay.

Yes.

Okay.

Good morning, and welcome to the second quarter Conference call for Graco, Inc.

If you wish to access the replay for this call you may do so by visiting the Companys website at Www Dot <unk> Dot com.

<unk> has additional information available in a Powerpoint slide 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 the opening remarks from management.

During this call various 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.

These reports are available on the company's website at Www Dot <unk> dot com and the SEC's website at Www Dot SEC dot.

I will now turn the conference over to Kathy John Locke Executive Vice President.

Controller and information systems. Please go ahead.

Good morning, everyone and thank you for joining our call I'm here today with Mark Sheahan, and David though I will provide a brief overview of our quarterly results before turning the call over to Mark for additional discussion.

Our conference call slides and our second quarter Form 10-Q on our website and provide additional information on our quarter.

Yesterday, we reported second quarter sales of $549 million, an increase of 8% from the second quarter of last year.

Reported net earnings were $117 million for the quarter or 68 tons per diluted share.

The effect of currency translation rates.

<unk> headwind in the quarter in both sales and earnings decreasing sales by 4% or $15 million and decreasing net earnings by 8% or $7 million, we expect.

Translation rate to continue to be a challenge for the remainder of the year.

At current exchange rates, we expect a full year unfavorable effect of currency translation decreased sales by 3% and earnings by 7% with the impact in the second half being similar to what was experienced in the second quarter.

The gross margin rate was down 300 basis points from the second quarter of last year and down 250 basis points from the first quarter.

During the quarter material cost accelerated from the already elevated levels of the previous year.

Our beginning of the year pricing actions were not enough to offset the impacts of these additional costs on the gross margin rate.

Given the cost increases we are experiencing we are implementing interim price increases across all segments and regions.

These pricing actions will begin to take effect throughout the third quarter.

At current cost and volume, we expect that our 2022 pricing actions will offset the input cost pressures on a dollar basis.

Of course, the cost of many commodities remained volatile and we will be closely monitored.

Operating expenses decreased $10 million or 7% in the quarter.

Sales and volume based expenses decreased $6 million against the high comparable in the second quarter of last year.

Currency translation rate also decreased operating expenses by $3 million.

The adjusted tax rate for the quarter was 20% due to the unfavorable effects of foreign earnings taxed at higher rates than the U S right.

We anticipate this trend will likely continue and expect our estimated annual tax rate will be 19% to 20%.

For the year to date, we have repurchased one 7 million shares for $120 million, which will more than eliminate dilution in 2022.

We also repaid $75 million of our private placement debt.

Capital expenditures of $89 million with $48 million related to facility expansion project.

And have dividend payments of $71 million.

Finally, our full year estimate for unallocated corporate expense and capital expenditures can be found in the conference call slide deck on page 10.

I'll turn the call over to Mark now for further discussion.

Kathy and good morning, everyone. All of my comments. This morning will be on an organic constant currency basis.

We had a good second quarter with record sales in all reportable segments industrial and process experienced broad based double digit sales growth in all regions.

In contractor North America remained positive, but EMEA and Asia Pacific saw declines in the quarter.

Sales to Russia, and the extended China shutdown contributed to the modest declines.

Product availability remained challenging and contractor due to component shortages and labor constraints at our suppliers.

Our consolidated backlog was $430 million at the end of the quarter, which is $65 million higher than at the end of last year and $190 million higher than the same period a year ago.

The electronic components.

Board assemblies electric motors gas engines, and certain castings remain bottlenecks.

Despite these challenges factory output was strong resulting in a $15 million decline in backlog from the end of the first quarter.

Since 2018, we have invested $425 million to expand our global manufacturing capacity.

This expansion has allowed us to support higher demand with increased output by nearly 30% during the same period.

These investments combined with improving component availability gives us confidence that we will be able to deliver enough products to reach our 2022 revenue outlook.

One more thing before commenting on our segments.

Since commodity prices and component costs have continued to rise.

We will be implementing another round of price increases starting with <unk>.

While we recognize the cadence is different than what we've done historically our actions are not isolated given the current operating environment.

We anticipate resuming our normal pricing cadence at the beginning of next year.

Now turning to some commentary on our segments.

After a very long strong second quarter last year and following several years of record growth. The contractor segment was up low single digits for the quarter.

Ongoing component shortages in this segment have resulted in delayed shipments to customers in all regions.

Incoming order rates have slowed in an environment of rising mortgage rates and lower home sales.

However, contractors remain busy and forecasts for our commercial construction and remodeling activity remain positive.

In addition.

We still have an elevated backlog of their $95 million, which is up 10% since the end of last year and is nearly double the same period a year ago.

Profitability improved sequentially in the quarter due to lower expenses and earlier pricing actions.

The industrial segment posted its sixth consecutive quarter of double digit growth.

This segment grew in all reportable regions and achieved second quarter records for sales and operating earnings resulting in strong incremental margins of 62%.

Despite the impact of the pandemic related shutdowns in China demand remains robust in multiple product categories.

Booking rates in Asia Pacific improved toward the end of the quarter. When these mobility restrictions were largely lifted.

Backlog is up $30 million compared to the end of last year and $60 million compared to the same time a year ago.

The process segment grew sales, 27% for the quarter, resulting in records for both revenue and operating earnings.

Strength in worldwide demand for lubrication equipment process pumps, environmental and semiconductor products.

Profitability for the quarter was strong despite some negative impacts from cost pressures on key components.

Moving onto our outlook.

Demand in the Americas remains firm in all segments.

Our outlook for EMEA remains cautious due to softening economic conditions and geopolitical uncertainty.

Pandemic related shutdowns in China also affected incoming order rates. However, once these restrictions were lifted we saw orders improved significantly.

With our backlog near record levels, plus the effects of our pricing actions.

We are confirming our 2022 revenue guidance of high single digits on an organic constant currency basis with growth expected in every reportable segment.

In closing I want to thank all of our employees for overcoming the many commercial and operational hurdles. We have seen in this difficult operating environment.

They make major contributions to our markets and customers everyday striving to deliver a plus customer service.

That concludes our prepared remarks, operator, we're ready for questions.

Thank you the question and answer session will begin at this time as a reminder to ask a question you will need to press star one one on your telephone.

Questions will be taken in the order that is received please standby for the first question.

Today's first question will come from Deane Dray with RBC capital markets. Please go ahead.

Good morning, everyone.

<unk>, Okay can we start with the decision to implement a intra year price increase.

And I expect that internally you all made a bigger deal out of this or anguished over it then.

We look at it from the outside because these are just extraordinary circumstances and I know it maybe legacy.

Was keeping you a little bit hesitant not pulling the trigger but it makes perfect sense, but just what was the deciding factor and how because it was always the sales disruption to your channel partners was the recent you held off but.

So it makes perfect sense, but how did you reach a decision and then thank you for clarifying you'll be back to the cadence and at year end.

In January as well thanks.

Since the beginning of the year and we started to see what we call negative PPV, which is a variance between what we planned our cost to be versus what they are actually coming in at now thats starting to creep into the P&L I would say kind of in the latter half of the March month of the first quarter and then as we started to work through the beginning of Q2 it became a little.

More meaningful so we did meet as a team.

At the facts.

Really across the board we are seeing.

<unk> substantial increases in a lot of the major components that we buy as an organization and we recognize that by sharing that being transparent with our customers.

Our distributors that we really had a good case to make to raise prices now versus waiting and so there wasn't much drama everyone participated.

All the different business segments and all of those different regions are all participating in the pricing actions that we're going to take in.

So far it's been.

Nobody likes a price increase rate, but we haven't really had any major pushback from any of our customers our distributors from what we've done got.

Got it well I would suggest distributors don't usually complain that loudly if at all but alright, but thats really good color I. Appreciate it and then just as a follow up for David can.

Can you comment on free cash flow and some of the dynamics, there with higher inventory buffer inventory and software because we're seeing that everywhere and did Youtube buybacks in the quarter.

I'll start with the buyback question, we did most of our buyback activity in the first quarter, but I think in Q2, we bought about 170000 shares at.

I think we've committed approximately $10 million or about $63 a share in purchase price. So the lion's share of the reduction.

Of the share creep had already been done prior to prior to Q2.

And I would add on that is yes.

Now on cash flow.

We saw improvement in operating cash flow in Q2 versus Q1, and Youre right. One of the big investment items was the I'd say the ongoing inventory build that we have been committed to as we.

Work through our current environment in some cases in a lot of cases, the inventory levels are elevated because we are waiting for that.

Exotic component that gold.

Golden screw.

And as we as we received those chips as we received those screws and bolts on O rings.

Wood in the normal course of business expect that inventory level to normalize as the year rolls along.

That's real helpful. Thank you.

Thank you one moment for our next question.

That will come from the line of Saree <unk> with Jefferies. Please go ahead.

Thanks for taking my question, so although a 49% gross margins are still relatively good.

Is the lowest level since I believe around 2009 for you guys. So with the new August price increase how are you thinking about gross margins in the second half and into 2023.

Yes, so we had not.

Not only the cost pressures that we've talked about but also the translation rates the currency rates really knocked about it think about 100 basis points off the gross margin this quarter. So.

Pieces, obviously hard to manage and there's not much we can do and through a long cycle those things tend to even out but when we looked at the pricing actions that we're doing.

Similar to what we did last year from the standpoint, we looked at our PPV, which I referenced before and we've made an estimate of what that would look like for the balance of this year than heading into I'd say like the first half of next year, and we really set our pricing actions to offset or neutralize that PPV that we that we were.

<unk>.

The wildcard is do costs go up from here or do they go down from here or do they stay flat.

Obviously, if you are in the camp that thinks that inflation is going to moderate costs are going to come down a little bit that should be beneficial to our gross margin rate.

But if they stay where they're at and they.

Even if they go up that would be sort of neutral to the right and maybe slip.

Slightly negative if cost accelerate so that's probably the best answer that I can give you Cathy is nodding her head a few has anything to add please do so no I think that sums it up really well I think that I would just add that on a dollar cost basis.

We have we implemented the price increase at the beginning of the year and on a dollar cost basis, I think you touched on it Kathy have capped.

The incremental pricing has offset those costs on a dollar basis. However, as mark touched on in Q2 watching where certain costs were certain prices for key components.

We we concluded that this was the time to make a further adjustment to make certain our to do a to increase the probability that we would continue to offset.

Incremental cost with price on a dollar basis.

Thanks, and then just a follow up on the buyback question. Obviously, you did a little bit of buybacks in the quarter, but you still have a net cash position.

Given the stock price reductions year to date, how are you thinking about repurchases and does it make sense to do anything more sizable with that cash.

Well I think our ill take a start here.

Our strategy over the long haul.

Ben has been and continues to be opportunistic.

I think that.

We look at we look at the current.

Macroeconomic environment is one where we see opportunities of commercially and <unk>.

<unk> in the world.

As you know we have a strong.

We have a strong capital position and are in the position to move aggressively when we make the decision to do so.

Yes, I think our priority. This year is really to eliminate the creep, which we've done and then as the go forward, we hope to be able to do that again.

Regular basis, but.

David's right, where we're opportunistic when it comes to the real strategic large buybacks and we're keeping our powder dry right now we'll see what happens.

Is there any talk internally about what's optimal balance sheet silhouette.

Internally optimal balance sheet was that the question.

What would what should it look like.

Well, we don't have any targets or specific things that we try to run the business based on but we have a lot of flexibility.

For when it comes to balance sheet management.

There is I understand the concept of balance sheet optimization.

My own view is.

Is that the real test of.

Call.

Financing strategy is how it performs in.

Alternative real world scenarios, and there is no doubt about it that we want to have the capacity to be opportunistic when the opportunities in the market come along as Mark said we.

Have a.

And M&A program that.

We will willingly.

I can only make investments in as we see good business opportunities and.

As <unk> seen over the last couple of years, we're coming off.

I should say in the middle of a major capital expenditure program that has already drawn several hundred million dollars investments and were not completed yet so.

Central to our evaluation of financial strategies is we don't want to certainly would not view it as a positive to interrupt any of our.

Our strategic plans.

In the event that.

No.

Underlying business conditions changed in the short term, we would think that's a mistake.

I appreciate the color thanks for taking my questions.

Thank you one moment for our next question.

That will come from the line of Andrew Buscaglia with Bahrenburg capital markets. Please go ahead.

Hey, good morning, guys good.

Alright.

So now everything this quarter was excellent at everything looks great on the margin front and youre pushing through price increases I just wonder.

Things are so good right now and we're starting to yes, there are.

Concerns around Europe , and broadly recessionary scenarios I'm wondering.

What's their mentality internally and maybe you could help us think through the segments most impacted.

Or how are the.

The dynamics affecting your businesses or segments that will be.

Kind of sort of worst case scenario.

Do deteriorate.

In terms of a slowdown but.

Certainly if you look at what's going on over in Europe with the geopolitical stuff that's happening over there and just overall forecast for GDP and industrial production being pulled back and then when you look at what's happening in the U S with rates going up in housing starts probably likely to come in sales of existing.

Homes are pulling back a little bit those are probably the areas that we're keeping our eye on.

Closest but.

In the meantime, we're not stopping anything from what it is we're trying to do to grow the business here, we're not cutting.

Cutting back on expenses, we are managing the P&L pretty tightly just making sure that we're making smart decisions but.

It's more or less business as usual for us and if things change we can adjust pretty quickly here at graco, we've got.

Good team and we can turn on a dime, if we need to so I feel I feel like as we sit here today as you said things are pretty good shape, we have a huge backlog in.

Hopefully we were able to put up the kind of numbers that we're targeting here for the year that everyone has gotten their models.

And maybe maybe just focusing in on the industrial segment.

The growth was really strong.

This pent up demand of years of kind of.

And our investment going on so.

Yes, I think I believe Europe , the biggest portion of that business, it's pretty impactful what.

What are you thinking based on what are you seeing based out of Europe that.

As it pertains to industrial how do you think that segment.

Segment will move if Europe does funds into a recession here.

Yes, I think Europe is probably the biggest chunk of our year Im sorry, industrial is the biggest chunk of our European business and its nice profitable business for us and if you really were to.

Put it into two different buckets, you've got the traditional Greg old legacy businesses, which are sealant and adhesive business in our liquid finishing businesses.

Typically go through a distribution channel.

So the integrators and things like that and then you've got our powder equipment business, which is the game of business that we've had.

In our portfolio for 10 years, or so now and Thats a little bit more project based they are a little bit more visibility on backlog and orders and looking across those two segments again.

And then as a part of that you sort of roll it up and you look at Okay. What do we think is going to happen in the forecast and Thats what gets us to this high single digit growth, including what's going on in Europe Asia, China Asia Pacific everywhere. So it's it's a mixed bag personally I do.

Think that Theres still plenty of project business going on over in Europe , and speaking with the team over there they're optimistic.

They feel like they've got good activities going on and a lot of our end markets and we really don't see that changing here in the near term and I guess, we'll see what happens.

And I guess Scott Yeah go ahead sorry.

No I just was going to say.

Yeah.

Mark gave a comprehensive answer the way I just would.

Summarize, especially on the industrial side the breadth of demand.

For the for the business for the segment.

The segment continues to impress me, both geographically and served markets.

The.

I guess the.

The margin capability incremental margin.

Length of the business has been.

Has been very solid and it seems to have a good foundation.

Including the realized pricing that we've seen that series of businesses generate and the quality of the backlog around the world, especially in that space and not to get too granular is.

Very is very good and very broad.

Mix of products the mix of geographies.

As I think.

Very solid.

Got it okay. Thank you.

Thank you one moment for our next question.

That will come from the line of Connor Lynagh with Morgan Stanley . Please go ahead.

Hi, This is actually Thomas on for for Colin or sorry for the mix up there.

Maybe just helpful for us to go back to the contractor business.

Could you just kind of frame up maybe end market demand there and how we should think about.

I realize maybe rough buckets here, but demand from remodeling versus new home builds versus can commercial construction, if youre able to just kind of help us think through.

We're aware of the risks would be and the magnitude of those potential risks here.

Yes, so we really don't break out the different groups in terms of.

Do it yourself versus propane, but what I will say is that we feel pretty good about where the Pearl contractor is right now today.

Generally speaking they have.

A good backlog of business that they are working through.

They're busy.

Base of customers and I would characterize.

The market right now is pretty healthy for.

For those people and of course, the Perot part of our product line is more profitable than the DIY part of the line. The DIY side is the area, where I think that people are probably more concerned about from the consumer standpoint is the consumer going to hang in there or are they going to pull back.

What's going on with inflation you look at like at the home centers foot traffic is down you guys probably know that but.

Again, similar dynamics, they're busy they got backlog they are working.

Labor is another factor that you should think about because <unk>.

Labor is tight and so by using.

Power equipment to do a job versus through on manual labor to job.

Youre more efficient number one but you also don't have to worry about finding labor in a tight market. So I think we're in pretty good shape, we will see what happens still bullish on that market long term, we're still way under built in terms of houses here in North America, I think something like four five or 5 million units that ultimately will.

We'll get caught up in that.

We think we're in a good spot.

Great. Thanks.

All from me so ill pass it back alright.

Alright.

Thank you one moment for our next question.

And that will come from the line of Matt Summerville with D. A Davidson. Please go ahead.

I'll start with that with kind of current state I think it's better that we were able to knock about $15 million off of the.

The backlog here in the quarter.

It feels to me like our our throughput from suppliers is better today than it was even three months ago, we're definitely not out of the woods yet but.

You look at just what's happened here.

Since the end of the year, it's about $65 million of additional backlog.

And we were at high levels, when we started the year off so.

Our throughput will be better and we hope to really make a dent in that backlog here throughout the rest of the year.

And then as a follow up is there any way I know to emit typical more typical year.

Typically go out and look for a 150 to maybe 200 basis points of price as we think about.

The price increase earlier this year, which is obviously I'm sure considerably higher than that and when we fold in what you are putting through in Q3.

Yes. The best we can do is give you the outlook and the outlook is high single digit organic constant currency for the year and beyond that really can't help you.

Got it thank you.

Okay.

Thank you as a reminder, if you would like to ask a question. Please press the star one one key.

One moment for our next question.

And that will come from the line of Walter Liptak with Seaport Global Securities. Please go ahead.

Hi, Thanks, Good morning, guys.

Hey, good morning, just wanted to do a couple of follow ups.

So I think what you were saying about contractors that pro painters are still doing great. There they've got a lot of work to do but the home centers you are seeing.

Lower throughput lower sell through at the home centers is that right.

Well I think that the.

Sort of the data that we hear from our own team and some of the other stuff. That's publish is foot traffic in home centers.

As reported as being lower.

Yes.

That.

I think has been.

I think there has been something that has been evidenced for.

For some for some months.

On the propane side just to underline a couple of Mark's point.

When we talk to our own team as recently as earlier in the week.

The professional contractors they check in with.

Theyre very interested not just in labor savings, which we alluded to but also they're very much even today hiring painters when they can get their when they can recruit additional painters to help them.

And it suggests a level of activity in that arena.

As.

Going to be pretty good I think for the foreseeable future.

Yes, I think my comments were more I think the question that was asked was what what are you keeping an eye on what might you want to look at.

What what.

Are you keeping an eye on what might you want to look at where some areas where there could be some weakness then I referenced the fact that that the DIY the low and the consumer.

Home Center traffic those things are things that for us to keep an eye on.

Okay, and just to refresh us how much your sales in home centers I think it's fairly small.

<unk>.

Yes, we don't we don't break that out we do not break that out.

Okay, Alright, and maybe in a similar way.

Contractor.

Maybe this one in.

In Europe , you guys do EMEA, but what how much is Europe .

Total graco sales.

Okay.

I mean, David do you have the number its around 20% 25%.

Told a photo of total total okay, great and then within contractors are much.

Contract or in Europe .

Yes, yes.

A nice sizable business.

A single, it's the single largest segment in Europe and it is.

It is I would say large largely a a pro paint as well as protective coatings market, which <unk>.

It gives it some level of presence in eastern Europe .

Including markets.

Markets like Russia, and the Middle East.

Okay, Okay that makes sense alright, thank you very much.

Thank you I'm showing no further questions in the queue. At this time I would now like to turn the conference back over to Mr. Mark Sheahan for any closing remarks.

Manufacturing is definitely one of our strongest competencies and it's been rewarding to me to see the teams rise to the challenge during the last two years, where we've had to battle, some really ridiculous cost pressures and supply chain constraints. I'd also like to just give a quick shout out to there are people in China for their professionalism and dedication during the lockdown there was any.

Suppose the last five days I think ill add more than two months and once the restrictions were lifted the team got back into the business.

We got orders and they start to get product out the door and they really responded very quickly what time.

Very very happy about finally, I'd like to acknowledge the efforts of our team in Europe .

Nobody predicted the force majeure events that have transpired in the last six months. The organization continues to impress us with their dedication and commitment of <unk>.

It's been an extremely challenging time for them and for everyone over there.

That concludes today's call. Thanks for listening and I Hope you have a great day.

Ladies and gentlemen, ladies and gentlemen, thank you for dialing conference you may now disconnect and have a wonderful day.

Q2 2022 Graco Inc Earnings Call

Request a DemoDemo

GGG

Graco

Earnings