Graco Inc. Q1 2023 Earnings Call

April 27, 2023

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Good morning, and welcome to the first quarter conference call for a great Co Inc. If you wish to access the replay for this call you may do so by visiting the company website at Www Dot <unk> Dot Com Graco has additional information available in a Powerpoint slide presentation, which is available as part of the webcast player at the request.

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 the 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 <unk>.

Item <unk> of the company's 2022 annual report on Form 10-K and in item <unk> of the company's most recent quarterly report on Form 10-Q. 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 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 shown rock <unk>.

Executive Vice President corporate controller and information systems.

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

Yesterday, Graco reported first quarter sales of $530 million, an increase of 7% from the first quarter of last year.

The effect of currency translation decreased sales by three percentage points or approximately $11 million.

Reported net earnings increased 28% to $129 million for the first quarter.

Diluted earnings per share were <unk> 75.

An increase of 29% over last year.

The gross margin rate increased 230 basis points in the quarter.

This improvement was primarily the result of the pricing actions, we have taken over the past 15 months.

As well as improved product and channel mix, which is mainly coming from our contractor segment.

Input costs remain elevated however, our pricing actions have taken hold and we are seeing improvements in our gross margin rate as a result.

At similar cost and volume, we expect that the gross margin rate improvement we experienced in the first quarter will continue throughout the remainder of the year.

Total operating expenses increased $2 million in the quarter.

Operating expense leverage along with top line growth and gross margin rate improvement led to operating earnings growth of 22%.

Interest expense decreased by $4 million in the quarter. This decrease relates to the prepayment of $75 million of our private placement debt that occurred in the first quarter of last year.

The adjusted effective tax rate was 19, 5%, which is comparable to the first quarter of last year.

Cash provided by operations totaled $91 million, an increase of $60 million from last year, primarily driven by net earnings improvement and a reduction in inventory purchases.

We also made dividend payments of 39 million and capital expenditures of $38 million.

A few comments as we look forward to the rest of the year.

Based on current exchange rates, we expect the effect of currency translation would have no impact on net sales or net earnings in 2023.

The unfavorable effects of currency expected in the first half will be offset by favorable impacts in the second half.

We now expect unallocated corporate expense to be approximately 34 to 37 million deaths.

This updated range reflects higher stock compensation as a result of changes in market based valuation assumptions.

Our full year tax rate is expected to be approximately 19% to 20% on an as adjusted basis and finally capital expenditures are estimated to be 200 million with $130 million related to facility expansion projects.

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

Kathy and good morning, everyone.

All of my comments this morning will be on an organic constant currency basis.

Sales were up 10% for the quarter and we achieved record first quarter revenue and operating earnings.

We saw revenue growth in all segments and regions with the exception of Asia Pacific, which had soft demand at the beginning of the year in both the industrial and contractor segments.

In Asia Pacific many of our key end markets remained strong such as E mobility battery alternative energy and electronics. However.

These are more than offset by softening sales in construction and powder, finishing.

As the quarter progressed incoming order rates rebounded and we anticipate growth in the region on a full year basis.

Pricing actions implemented last year drove sales growth and gross margin expansion during the first quarter, our strong price realization across all businesses and regions along with favorable product mix.

Contractor resulted in a meaningful improvement in our gross margin rate, which has risen to normal graco levels that were last seen in the first quarter of 2021.

These improvements along with good expense management resulted in companywide incremental margins of 80%.

Operating earnings expressed as a percentage of sales were 30% for the quarter.

Which is the highest in company history, Despite continued foreign currency pressures.

Our pricing strategy over the past couple of years has been to cover rising input costs and to restore the gross margin rate to pre inflationary levels with.

With similar volumes for the rest of the year, we should see continued strong margin performance.

Our consolidated backlog was $350 million at the end of the quarter, which is consistent with where it was when we ended last year.

While supply chains are improving we still have shortages in key components, such as electronics and castings, which have prevented our backlog from returning to more normalized levels.

Now turning to some commentary on our segments. The contractor segment had mid single digit revenue growth, resulting in first quarter Records for both revenue and operating earnings are pro paint and high performance coatings and form businesses remained strong but were partially offset by ongoing softer.

Conditions in the home Center channel.

This change in demand at the home centers was not unexpected given the large ramp in business we've experienced since 2020.

Growth in EMEA during the quarter was a bright spot as product availability improved and they had strong price realization.

Asia Pacific on the other hand declined 8% as the shipping container business in construction markets have weakened.

As expected new single family housing starts in North America slowed during the quarter, but improving commercial and multifamily residential were more than enough to offset the decline.

Professional painting contractors remain busy with order books extending throughout much of 2023 and even into 2024 for commercial applications.

Operating earnings were 30% during the quarter as CET benefited from selling larger pro paint sprayers and fewer home center units.

<unk> actions also contributed favorably in the quarter versus what we experienced last year.

Incremental margins in contractor, we're more than a 100% in the first quarter.

The industrial segment grew 7%, resulting in record first quarter revenue and operating earnings are liquid, finishing and sealant and adhesive businesses led the way, but were partially offset by lower system sales and our powder, finishing business, especially in Asia Pacific.

Backlog in powder equipment systems remains elevated overall, which should offset the softer start to the year. Additionally, we expect to benefit from new product releases in the back half of this year.

The process segment grew 16%, resulting in first quarter records for both revenue and operating earnings.

This is the ninth consecutive quarter that processes set. These records continued broad based sales growth in vehicle service industrial lubrication process transfer pumps, environmental and semi conductor drove this strong performance.

Pricing actions taken along with careful expense management drove 75% incremental margins for the quarter and resulted in 30% operating margins, which is a record for the segment.

Momentum continues to build as project activity and lubrication environmental and process pumps, a robust backlogs remain elevated particularly in semiconductor and there is excitement around our recent upcoming new product releases.

Moving on to our outlook. We are encouraged by the start of the year end market activity and demand for our new and existing products remains solid.

However, given the volume comparisons in the second half will be more challenging as we lap some of the price increases we took last year, we'll continue to watch incoming order trends in business tempo as we remain optimistic for both growth in both sales and operating earnings for the full year. Therefore, we are confirming our outlook of low single digit organic.

<unk> revenue growth on a constant currency basis.

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

Thank you for the question and answer session will begin at this time as a reminder to ask a question. Please press star one on your telephone and wait for your name to be announced to withdraw your question. Please press star one again.

Questions will be taken in the order that it has received please standby for your first question.

Our first question comes from Deane Dray with RBC capital markets. You May proceed.

Okay.

Good morning, everyone.

Hi, guys.

Just you gave a lot of good color in the prepared remarks regarding end markets, but maybe just take us through.

End market performance versus expectations, and we can start there. Thanks.

Yes, I think overall, we're really happy with how things played out in Q1, there probably came in a little better than what we were anticipating when we started out the year I would say that the growth is pretty broad based across multiple product categories and across most of our business units and regions.

Of course, there is some hotter spots in colder spots, but in aggregate.

Backlog is kind of stayed flat from the beginning of the year and I guess, we're off to a good start so.

There is not much more that I can say other than.

It's been good so far.

Got it and then it sounds.

Hockey too the other industrials this quarter or the supply chain improvements have been coming through pretty smoothly.

Out of the woods, yet, but it sounded like youre still seeing enough pressure and.

Electronics and cash seems to have to call. It out so some color there how do you expect that to normalize.

Might have missed it but did you do the annual price increase in January .

To see that.

Take off yet.

Yes. Good question, Yes, we do still have a couple of hotspots on the supply chain I would say, it's much better than it was even in late third quarter and the end of the last year. So things are improving but we have those two areas that you called out are still creating some pressure for us and I will also say that we are.

Still seeing inflationary pressure.

<unk> are up we track what we call purchase price variance, which is what we actually pay versus what we thought when we set our budgets and that is still running unfavorable against what we had planned so our pricing actions that really helped to off offset that we did implement price increases at the beginning of the year Selim.

<unk> not across the board, but in a number of the businesses in the regions. So that that should help as we.

Work through backlogs and those start to hit say this is David maybe I can offer an antidote.

Illustrate.

The supply chain situation last week I spoke with one of our factory managers and XI and XI drew a comparison from a year ago to currently.

What her.

Save or gaps were in key products that we're keeping her factory from shipping products and a year ago. She looked at her list and there were 30 items that were interfering with the major items that were interfering with the flow of.

So a product out the door. She has continued to do that we probably always do it at graco always have something short, but by comparison at least in the last week. She was talking about fewer than 10.

So lots of progress I think I think that would be something that we would see across our system lots of progress has been made there, but they are still our key gaps as mark highlighted.

Thank you.

Thanks, Dave.

Thank you.

Our next question comes from Mike Halloran with Baird You May proceed.

Hey, good morning, everyone.

Hi, Mike.

Can you help me make sense of the process and the contractor margins you referenced it but I mean honestly robust records in both segments.

Probably speaks to some of the price cost catch up reduction some of the efficiencies, but maybe a little bit more help on what drove that magnitude and then also how should I think about what's sustainable at those levels.

We havent been here before I mean, it's just the right run rate to think about on a forward basis are there are some puts and takes mix whatever it is that that changes how we should be thinking about this over the next.

Call it remainder of the year moving forward. However, you want to think about it.

Yeah, I'll start off and Kathy.

Kathy Andrew David can chime in as well we've done some work around this just.

Make sure that we had good information to share with you.

Really what we said in the preamble, it's really a combination of and contractor. It's a combination of their pricing actions that they took which were substantial as you recall they had probably the most pressure from a cost standpoint of any of the other businesses.

And then in combination with that.

Really nice growth on the professional paint side and the high performance coating and <unk> businesses, which were in the industrial portfolio. A couple of years ago, and those are higher margin businesses and combine that with a decline in the home center.

Business and that really.

The story for contractor on the margin rate. There, we think it's sustainable going forward to the extent that we continue to get volumes and at the same levels that we've seen so far this year and Thats really where the wildcard is for us.

<unk>.

Kind of a look forward on gross margin rate and CBD. There is nothing inherent that would cause us to be concerned about margin rates other than incoming orders.

On the other businesses our process businesses.

Really a great story in that we had growth everywhere.

We have the way we look at it there's like four big product lines in there theres our process pump business as our environmental businesses Theres, our lubrication businesses and then there's our semiconductor businesses.

And again, it's a combination of the pricing actions that were taken in those units.

As well as.

But to be able to get more product out the door as the supply chain has improved and working through backlog that got to those levels. So I think that there as well as long as volumes hang in there. We believe that the margin rates you saw and that we saw in the first quarter should be.

Sustainable.

Great that's.

Super helpful.

Then just from the outlook perspective, I can certainly understand the lack of visibility on a forward basis and widespread a really good quarter, you held that low single digit thought process.

Any areas I know you called out Asia, but anything that you would point to in the order rates or anything else you are seeing in the business, where there would be a sign of greater caution from your perspective or is a lot of this just perspective based on.

Leading indicators that it may be a part of your business, but maybe more macro oriented leading indicators.

Yes, I would say that.

I would just start out by saying that given the really high percentage of our business is short cycle forecasting for US is probably just slightly better than go onto a fortune teller times.

So and we're trying to give our guidance and our forecast.

We're really taking into account the things that we hear about in the economy.

The input from our teams on what they are seeing the end markets. The end markets appear to be pretty good but there's enough uncertainty out there were at this time, we just feel like it's best and most prudent for us to hang onto our outlook number.

We will take more well definitely take more business. If it comes in if it does it's going to be great, but for now I think that area on the side of caution makes some sense, yes, I would agree with everything said.

I would add that something that we've talked about now for 18 months is this backlog build and we have seen backlog conversion really beginning in the fourth quarter and good progress here.

In the first quarter, which by the way is what we want we want to work through backlog because.

We are a short cycle business as you know and as part of our value proposition that we strive to be the best in.

Customer service and deliveries.

So if the I would say that.

That <unk>.

Backlog conversion continues to be a factor in our business, we do really get back in most of our legacy businesses to the short cycle a little later in the year and then we get into the visibility issue that Mark talked about.

Great.

Certainly helps I appreciate it everybody and really really impressive stuff.

Thanks, Mike.

Thank you.

Our next question comes from Cerro Verde.

<unk> with Jefferies. You May proceed.

Hi, congrats on the quarter.

And so obviously margin performance really Sean, but industrial margins and you saw some pressure versus prior year is that a reflection of higher margin sales in China being weaker or is there anything else that we should think about there and does that mean for China potentially stronger following the first quarter.

Well, they're really high margin rates to begin with and we're really happy with the profitability of that business. So I kind of view the quarter as being flat 13 weeks short time period. There is always some puts and takes mix and other things that go into it so.

No concerns at all about them being able to sustain or maybe even slightly improve if volumes continue to be where they are at or higher.

Okay, and then obviously you still have a lot of cash on the balance sheet you bought back shares in the corner, just maybe update us on how youre thinking about share buybacks for this year.

And maybe M&A.

Well I think that.

As we've discussed as we've discussed before we have a pretty I think our approach to deploying capital.

Been consistent.

And.

We continue to focus on first our organic opportunities and you said you saw an uptick in.

R&D.

This quarter end.

Consistent with some of the new product expectations.

Mark touched on.

We've got a very aggressive cap.

Capex program, that's continuing this year with the construction of our new warehouse in Dayton, Minnesota.

The gamer expansions that we've talked about and we're breaking ground.

And in OCA.

Our lubrication.

Operation has its headquarters.

It's going to be another big year for capital as far as the two items you mentioned I would say on the M&A front, if I had to generalize.

Conversations and opportunities.

Come to our attention frequently.

If youre looking for a little bit of color in terms of the market environment. What I would say is there are there seemed to be fewer participants on individual initiatives and projects as far as.

Possible.

<unk> purchases, but I would.

Reinforce I think what we've talked about before which is good merchandise remains at.

At.

Solid prices, so hopefully the kinds of things that we're looking at resemble those sorts of opportunities, but I think that there are deals out there and there may be a smaller number of non strategic there is certainly a smaller number of non strategic participants than before as far as as far as lastly.

The share repurchase.

Our approach for years has been opportunistic I think we demonstrated for example last year that.

When we think there is an opportunity at good prices, we can be aggressive we deployed about a quarter of a $1 billion in 2022 and yes.

I'm glad you saw that we made some modest purchases this year end.

Vince will drive our activities over the remainder of the year.

Looks like it could even go to that yesterday.

On the call.

Yeah.

Yes, Terry you've told me before I'm a little slow.

Yes.

Thank you and as a reminder to ask a question. Please press star one on your telephone.

Our next question comes from Matt Summerville with D. A Davidson <unk> company you May proceed.

Thanks.

Couple of questions is there any way you can maybe directionally help us a little bit in terms of overall core growth of an impressive 10% in Q1, roughly how much of that is price versus mix versus volume is there any way to help us parse that out a little bit I.

I guess I'm trying to get at is looking forward how much incremental price is yet to be realized based on the timing of the second increase last year.

Plus the portion of the business that is subject to the 2023 price increase.

Yes, I think I said in my comments that really most of the growth this quarter came from our pricing actions.

Stick to that comment just as an overall give you some guidance on what's going on there. We did put through price increases like you said I think the second one got put in in the third quarter early third quarter late second quarter.

So we've got some I'll call it tailwind up until we anniversary those but as I said before too we did put some pricing in here at the beginning of this year as well so.

All in all we are.

Happy that we did what we did really just trying to offset some of the input costs that we have in.

That's where that's where we stand today.

And then Mark that you have a follow up could you maybe talk about what you saw sell in versus sell through in both the professional paint and home center channel as it pertains to contractor and what your view is there on channel inventory across those two.

Customer banking.

From a general perspective, I would say on the pro units the sell in sell through is pretty flat even consistent so it wasn't like they were building inventory and it wasn't like they were drawing down inventories, though were seeing like our demand was matching what they were experiencing out the door in most of the most of the locations.

Where we have that type of equipment on the home center side.

More of the decline on their inventory did.

Impact our result, I think their inventories are down a little bit compared to where we would've expected them to be for Q1.

So they are likely experiencing.

Less demand at the store level and they'll manage their inventories according to what kind of foot traffic, they're getting in the stores and of course our.

We're very.

Vic to respond when they do order so.

We're responsive if they if they make a change in inventory levels.

Hits us pretty quickly.

Let me say thank you.

Yep.

Thank you.

Our next question comes from Walter Liptak with Seaport Global Securities You May proceed.

Sure.

Alright, thanks, guys congratulations on a nice quarter.

I'm getting on the call a little bit late so I wanted to so I apologize if you've been over this already but in contractor I wonder if.

Maybe as a follow on to some of them.

Last question.

Any insight you can give us.

Sort of.

Geographic regions.

Or are you seeing.

<unk>.

Besides price that you could talk about on the volume side.

Well I would say that certainly contractor as we've discussed in other occasions.

There's many segments in the market to consider.

And.

Definitely we saw as Mark alluded to we saw some really good strength.

And.

Here in North America in the.

Commercial and multi family side of the business, which is.

An important part of our.

New construction.

We also have seen good business performance in the installation market and even in and the protective coatings space for infrastructure.

And the heavy duty applications I think one area. We've tried to call out is in the regions.

Asia has gotten off to a slow start for contractor and if we had to be more specific China and here again in the comments I think we've talked about.

The construction market in China, I think we can safely say is going through a little bit of a pause and we have seen.

The.

Big.

Big opportunity for contractor in the protective coating side is the container market in <unk>.

Country in China, and that tends to be a boom robust environment in 'twenty, one and 'twenty two we're really hot for the container markets and with the I'll call. It the rebalancing that's gone on in the world on logistics and getting containers back in the right spot.

That's going to go right.

Right now so that's another area of softness.

Okay, Great Yeah, that's what I was looking for.

Thanks for the answer.

Thank you there are no further questions I will now turn the conference over to Mark King.

Alright. Thank you very much in closing I would like to thank Cathy Schoen rack for participating on these calls the last few years and also congratulate her for moving into a new role as <unk> Executive Vice President and Chief Technology Officer reporting into me I'd also like to congratulate Chris can Knudsen, who many of you know through his.

Excellent efforts, leading investor relations over the last few years, Chris will become our new executive Vice President and corporate controller reporting to David Lowe Im excited about the energy and focus that these two people will bring to their jobs.

They are very important for graco and we're excited to get them into those roles. So with that we'll conclude the call. Thanks for participating have a great day. Thank you.

Hey.

Thank you. This concludes our conference for today. Thank you all for participating and have a nice day all parties may now disconnect.

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Graco Inc. Q1 2023 Earnings Call

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