Q2 2023 Graco Inc Earnings Call

July 27, 2023

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 company website at Www Dot Graco dotcom.

<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.

These remarks constitute forward looking statements for the purpose of the Safe Harbor.

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 2022 annual report on the Form 10-K.

In the item one a.

Of the company's most recently quarterly report on Form 10-Q.

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

<unk> 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 Kris Newton Executive Vice President corporate controller.

Good morning, everyone and thank you for joining our call I'm here today with Mark Sheahan, 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 second quarter sales of $560 million, an increase of 2% from the second quarter of last year. The effect of currency translation decreased sales by one percentage point or approximately $3 million.

Reported net earnings increased 14% to $134 million for the second quarter diluted net earnings per share was <unk> 78.

An increase of 15% over last year after adjusting for the impact of excess tax benefits from stock option exercises diluted net earnings per share was <unk> 75.

Based on current exchange rates currency translation should have no effect on full year net sales or earnings we expect the unfavorable effects of currency that we saw in the first half of the year will be offset by favorable impacts in the second half.

The gross margin rate increased 310 basis points in the quarter strong price realization was favorable product and channel mix, mainly in the contractor segment was more than enough to offset higher product costs.

While material cost increases have moderated compared to what we experienced last year headwinds from lower factory volumes and increased factory spending have put pressure on our gross margin rate for the quarter and year to date factory volumes have softened as the year progressed as lead times supply chains and customer order trends start.

Normalized.

Total operating expenses increased $14 million or 12% in the quarter, primarily from rate based increases of $6 million and incremental share based compensation of $4 million.

Gross margin rate improvement more than offset these increased operating expenses during the quarter, resulting in operating margin rate growth of one percentage point contractor operating margin increased one percentage point compared to the second quarter last year sequentially contractor operating margin decreased three percentage points from there.

First quarter, largely due to new product development spending unfavorable channel mix and unfavorable factory volume related to inventory reduction initiatives for the full year, we expect unallocated corporate expenses to be approximately 34 million to $37 million, but timing can vary by quarter.

Non operating expenses decreased $5 million as a result of increased interest income on cash held and the favorable effect of market valuation changes on investments held to fund certain retirement benefits.

The adjusted tax rate was 19% for the quarter, which is consistent with our expected full year tax rate of approximately 19% to 20% on an as adjusted basis.

Cash provided by operations totaled $282 million for the year, an increase of $147 million from last year, mostly driven by higher net earnings and a reduction in inventory purchases.

Cash provided by operations as a percent of net earnings is 107% for the year Cigna.

Significant uses of cash year to date or dividend payments of $79 million and capital expenditures of $92 million, we estimate capital expenditures for the year to be $200 million with $130 million related to facility expansion projects. Finally, subsequent to year end or quarter end, we re.

Paid $75 million of our private placement debt, including a prepayment fee of $700000, which will be recognized as interest expense in the third quarter of this year.

Now I'll turn the call over to Mark for further segment and regional commentary.

Thank you, Chris and good morning, everybody.

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

Sales were up 3% for the quarter, we achieved record second quarter revenue and operating earnings driven by strong results in both the process and industrial segments.

Contractor performance remained mixed with growth in pavement protective coatings and spray foam unable to offset softer sales in the home center and pro paint channels.

EMEA was a bright spot during the quarter growing 5% compared to last year with growth in all reportable segments.

Incoming order rates in many key product categories have been solid and sales have improved as many of the adverse component and product availability issues that impacted EMEA last year have improved.

Operating margins were strong for the quarter as we continue to benefit from our pricing actions in 2022 and 2023.

Price realization in the businesses and regions accounted for nearly all of our revenue growth and significantly contributed to our companywide incremental margins of 75%.

With similar volumes and costs for the rest of the year, we expect to continue to see solid margin performance for the remainder of 2023.

Our consolidated backlog.

Was $330 million at the end of the quarter down $20 million from the end of last quarter.

Issues with supply chain and component availability have improved modestly.

Better component availability has allowed us to increase our customer service levels, although we still have room for improvement.

Now turning to some commentary on our segments the.

The contractor segment experienced a low single digit revenue decline in the second quarter driven by less demand in the home Center channel slowing construction markets in China and softer demand in the North America Pro paint channel.

Somewhat offsetting these headwinds were growth in our payment in high performance coatings and spray foam businesses.

New product introductions were also incrementally favorable for both the quarter and on a year to date basis.

We believe that the current inventory levels within the home center channel are reflective of foot traffic in the stores and out the door sales.

The decline in the North America Pro paint channel compares to strong second quarter sales last year. When we made a significant dent in our backlog back orders to key customers after component shortages started to ease.

Growth in EMEA during the quarter was largely due to improved product availability and strong price realization.

Asia Pacific on the other hand declined 6% as the shipping container business and construction markets were weaker than a year ago, especially in China.

Despite the soft quarter, we are optimistic for the balance of the year as contractor activity remains solid and we are seeing improvement in key economic data related to U S housing starts and existing home sales along with continued strength in commercial construction spending.

The industrial segment grew 4%, resulting in record second quarter revenue and operating earnings.

Activity in key end markets, such as alternative energy electronics and battery has been robust.

Incoming orders in our liquid, finishing and sealant and adhesive businesses remained solid but were somewhat offset by continued softer demand in our powder, finishing business, especially in Asia Pacific, However, backlogs and powder equipment and systems remain elevated giving us confidence for a better second half of the year.

The process segment group sales, 14%, resulting in second quarter Records for both revenue and operating earnings.

This is the 10th consecutive quarter that process is set these records.

We saw continued broad based sales growth in all product categories. However, vehicle service automatic lubrication and semiconductor were the key drivers of the impressive performance this quarter.

Steady volume.

Strong pricing and good expense management resulted in incremental margins of 76% for the quarter and operating earnings of 31%, which is another record for the segment.

At similar volumes, we believe the current operating margin rate is sustainable and we are pleased with the strong margin progression that has occurred in this segment the last two years.

Moving to our outlook.

Our results for the first six months were essentially in line with our expectations and market activity can be broadly characterized as having pockets of both strength and weaknesses overall, we're seeing modest sales growth drive.

Strong earnings leverage.

Current order rates, along with elevated backlogs give us confidence that we will attain our full year revenue guide of low single digit organic growth on a constant currency basis.

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

And thank you.

As a reminder to ask a question. Please press star one on your telephone and wait for your name to be announced so withdraw your question. Please press star one again.

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

And one moment please.

And our first question comes from Deane Dray from RBC capital markets. Your line is now open.

Thank you and good morning, everyone.

Hey.

Could you expand on the point on the pro paint.

Al.

It sounded like there was a lot of.

Backorder inventory that you were finding were able to ship.

Did that have an impact.

On this quarter that there.

It was more product availability and so forth.

It sounded like that that was kind of either like a rubber banding of.

The product going into the channel just some clarity there please.

I think in.

And David and Chris can kind of comment too, but I think what we were trying to highlight was that a year ago.

We had a lot of back orders and we did free up some components in the factory to get product out the door in Q2 that might've been a little bit higher than normal just because we had such a.

A huge amount and so when youre looking at comparison to last year.

That was really why I think we saw a little bit tougher comp.

And I would just add this is David I would just add that I think it's also true in the mindset of the buyers in the in the contractor channel generally both propane and home center, we have our most sophisticated point of sale systems and people and a year ago.

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Studying our fulfillment rates I think it's safe to conclude in a confirm this with our factory people.

They were they were submitting extra orders because of anxiety is about when we and other vendors would get product to them. So I think it's a combination of orders were exceptionally aggressive probably over and above out the door sales last year, along with Mark said it was about a year ago when we release.

Sorry.

Meaningful free up in some of the key components that we're blocking shipments.

Alright, Thats really helpful. And then just to clarify on the home center it sounds though that day.

Stocking has has that run its course, so sell in versus sell through is now more balanced.

Yes, I think when we talk to the teams that actually are in the field and they are looking at what inventories are in the stores. They feel like right now they're in a good spot given the level of activity that they are seeing in foot traffic and activity within the stores. So.

You never really know Deane right I mean things can change, but at least for now we think that the major home centers are in an inventory level that is acceptable given what they're seeing.

Right and then just lastly on the.

Traffic light slide on it looks as though the.

The Asia.

Conditions have worsened the touch but that was not enough to have you changed the.

Our outlook for the year for sales.

Yes.

I think thats accurate I think you've got one thing that.

When we look at Asia, I mean the mall.

The majority of it is really the industrial business I mean, we do some we do have CD, it's meaningful but.

When you think about all the activity that's going on in industrial.

With all of the alternative energy stuff.

And if you look outside of China, we saw a nice activity in Korea, Japan and Southeast Asia.

Also Australia, so I think we're pretty comfortable with what we've got there.

Real helpful. Thank you.

Yes.

And thank you.

And one moment our next question.

And our next question comes from Michael Halloran from Baird. Your line is now open.

Hey, good morning, everyone.

<unk>.

So following up on the Dean's questions. Just if you look at the back half of the year is the thought process and on the contractor side sequential stability from current levels kind of following normal seasonality.

Or is there some other assumption we should be thinking about.

Yes, I think what we look at the level of incoming orders that we have and the backlogs that we still have our backlogs are down but they are still higher than what they would normally be we feel pretty good that the outlook should hold up for the back half of the year.

Yes.

I would just add.

Maybe this is my own. This is my own view that absolutely. We have we have backlog we have back orders and if you think about our segments.

Would say that the process and the industrial segments have backlogs at this juncture elevated to a somewhat higher degree than what we see in contractor my view on the contractor side.

<unk>.

Im reluctant to use the word normal after the experience of the last couple of three years, but in talking with our field people as Mark indicated in our operating people my sense is in the in the major product categories for propane home Center.

And increasingly the protective coating space.

We are enjoying backlogs that are much closer to the historical model than what we've seen anytime since since 2019.

Okay. Thanks for that process side, obviously, the margins have been tremendous.

Can you help a little bit on the.

The drivers of the strength on the top line side of things.

It's a lot of moving pieces and not a ton of visibility from our side of the fence on a lot of those moving pieces.

Vehicle services, you highlighted it's a strong point seemed.

Seems stronger than the environment would necessarily indicate so if you could just give some more context not just in vehicle services, but all the things going on underneath the hood how much is breakdown how much is the markets. How much is just really dynamic pricing and just give us some more context on that overall picture.

Yes, I'll take that I appreciate the question because I do believe that it's just been a wonderful success story within graco, what what's happened within that segment over the last couple of years and it wasn't that long ago I remember the operating margins were in the teens so 31% in.

It looks like we still got some runway there to expand beyond that but it's been good growth across really multiple different business units and product categories, including a number of the ones that we've acquired over the last.

Five years or so so our late night.

Semiconductor business has remained strong.

And the outlook for semiconductor at least next year looks to be fairly good. So that's been a nice development there our environmental businesses.

Where we're moving fluids around in landfills.

They are spending more money this year than what we've seen over the last couple of years. So you look at the Republic services waste management, they are a little bit more inclined to make investments and so we're realizing some of those benefits lubrication has been a really nice business for us the team there is X.

<unk> extremely well, it's not just the vehicle service side, it's also our industrial lubrication business.

Which competes in about $1 billion revenue market and we are.

Growing nicely in that market by expanding our product line and improving our service levels and hopefully we can continue to.

Gain OEM presence and drive that business higher I feel like there is a fair amount of runway for growth there that that team has and vehicle service.

All I can tell you is that.

Dealers make money on getting people into the dealership and the best way. They can do that is to have you come in for an oil change and when you go in and they want to make sure that the amount of oil that they put in your vehicle is tracked it's monitored and it's put in.

Accurately because a lot of these oils are pretty expensive and so they're driving more customers into the dealership doing an oil change and then of course hopeful that they'll be able to find other things to sell you as well. So again I. Appreciate the question I think that our process segment is really a great story within.

Gregg go we're really excited about it and I know the teams are executing extremely well.

No that was great last one maybe just talk to what you are.

Inventory levels are great because inventory levels are.

And how you see that trending and what it means for cash flow as we look over the next six to 18 months.

Kind of like Chris take this one.

So our inventory level currently is pretty flat with where it was.

At the beginning of the year.

We do have some inventory reduction initiatives that are underway, which has started to drive down some of that inventory, especially within the legacy businesses.

I think youll see for the rest of the year, we will continue with less of the inventory purchases as we continue to drive that inventory down to a lower level than we've seen historically as we've seen improvements in both the supply chain and product component of our component availability.

Great. Thanks, everybody really appreciate it alright, thanks, Mike.

Thank you.

And one moment our next question.

Okay.

And our next question comes from Savi <unk> from Jefferies. Your line is now open.

Okay.

Hi, good morning.

So I just wanted to focus a little bit more on the margin gross margin step down sequentially. Despite the higher dollar.

Drove that.

Do you need to see for margins should accelerate from here.

Well I mean, there is there is a couple of things I think that for sure mix, particularly in contractor.

It wasn't as favorable as it was in Q1 for example, so a little bit higher come.

Coming out of the home center as a percentage of their total.

Revenue.

The price realization has been has been good we are offsetting our cost I would tell you that chris's comments upfront about factory volumes being down is something thats, putting a little bit of pressure on the gross margin and if you look sequentially at what happened between Q1 and Q2.

We did drive inventory down by about $20 million in the factories are very cognizant that our inventory levels have have grown by quite a bit over the last two years as we wrestled with all the supply chain. So we are really pushing the teams there to make sure that we're producing and what we're selling and.

Take concerted action to try to pull some of that inventory back and I think youll see that showing up on the cash flow statement, where our cash flow is dramatically better than it was last quarter and a year ago. So overall.

Arjun rates are decent.

And I feel like we're in a good spot for the rest of the year to maybe put some more points on the board there.

Thanks, and then just.

Not to beat this but on the incremental margins industrial came in lower than I think we would expect that I don't know if that's what the factory volumes, but.

Is that factory volumes lower growth in APAC or just what drove that.

Yes.

I think that the overall industrial results were down like 100 basis points for the <unk>.

Quarter over quarter, and what I would tell you is that in any 13 week time period, there's going to be some volatility in there I don't think theres any thing systematically different in terms of what's going on in that business than others. So.

Again, I feel like overall absolute levels of profitability. There are really good there might be a little bit of variation from time to time, but but not no problems.

I appreciate the color thanks, Jeff Thanks, Mary Anne.

Thank you.

And one moment our next question.

And our next question comes from Matt Summerville from D. A Davidson <unk> company. Your line is now open.

Thanks, Mark I, just wanted to get back to process, a little bit and maybe just talk about how sustainable you think the demand is there looking out over the next few quarters in the context of where do you feel the segment teams in the cycle. If you will and when you look at the second quarter should we consider.

This to be a new kind of base run rate of business of 140 million you did in the quarter. If I look back. This business has been phenomenal to your 0.7 straight quarters of quarter on quarter growth.

I guess I'm, just trying to get a feel for what the go forward view as relative to this second quarter performance you guys turned in yet.

Yes, I really like what we've what we're doing there across really all of the different product categories. The ones that I mentioned in particular, the one I didn't mention which is also exciting is the big push by every factory in the world to reduce energy costs and as a result of that moving to electric.

Drive diaphragm pumps as an area, where we think we have a very good competitive advantage, we launched a product called quantum it's on our website you can look at it nobody else has that technology.

Because we own the motor technology that goes into that pump and so that is a trend thats going to play out.

For several years and I think we're really really well positioned there.

And also that segment, whether it's in industrial applications or the lubrication applications are at really all the sanitary food.

Food and beverage all of this stuff they get into.

It's probably the most fertile ground for us when it comes to M&A hunting.

And we've built a business there now that I think can be leveraged to the extent that we find attractive targets that we can bolt into the operations there.

Im very pleased with the team we built a new factory Forum last year, they've moved up there it's up in Dayton, I'd encourage anybody to come and visit that wants to see it.

A lot of good things happening in the process.

Appreciate the color and then I just want to put a finer point on contracting to make sure I.

The picture right. So can you talk about the relative performance of the propane business versus home Center in North America, and I think you mentioned sell through looks like it was kind of matching sell in with home Center is the same true in the propane side of things.

Yes, I think that to the latter question, yes, I think that the inventory levels on the propane side are at a level that is reflective of the business that they are seeing both both were down.

In the quarter, so I'd want to sugarcoat that.

But.

Both both pieces of the business, both pro and home center were down what I, what I will say is that when we talk to the pro painters and the contractors that are out there doing jobs. They still have they still have business.

Are pretty busy.

And anybody that's involved in commercial is particularly busy these days so.

Despite all of.

The potential for Doom and gloom that came along with interest rates going way up and in housing.

Activity slowing down we're hanging in there pretty good.

We've got these other nice niches that we're in like line striping and texture and spray foam and protective coatings that.

That really help kind of smooth out maybe some of the more volatility that you might see in the business as it just relates to residential housing so all in all.

Not too bad.

Should we well enough alone because I agree with everything and Mark summary, the way Im thinking of it is certainly when we talk about construction and contractor activity here in North America, the macro data both on the commercial side and frankly on the residential side is coming through stronger and forecasts.

Cash that we've seen as recently as coming through in the last couple of weeks.

Virtually every category of investment in the commercial space and also in the residential space is better than the previous forecast and I guess on the second point reiterating because I think it is important.

At the at the point of sale.

The channel partners.

And our own salespeople on their checks really.

For the most part believe that I'll say.

This is what they want wholesale and retail or inventory levels stocking points are in line and I think that this would be this is important because it means if so or if its mostly true.

Then we have largely seen our model revert back to where it was three or four years ago and contractor being and this is a good thing by the way because this is one of <unk> strategic advantages our ability to have very high fulfillment levels and if that's the case, we're back to where you need back to the old model.

<unk>.

If you will you eat what you kill and the short cycle nature of the business will be what drives results in that business over the balance of this year and going into 'twenty four but the underlying fundamentals positive enough I feel pretty good about that.

Thank you guys I appreciate the color thanks, Matt.

Thank you.

And one moment our next question.

And our next question comes from Jeff Hammond from Keybanc capital markets. Your line is now open.

Hey, good morning, guys.

Morning, Jeff.

Hey, just.

I think you gave a backlog number and so it was down 20 million sequentially I think 330 $330 million just wondering.

What you think is.

More reflective of our normal backlog in.

How long of a period, where we start to where we see these kind of lower orders to get back to normal and then along the same lines. I think you said you were kind of under producing to bring inventories down and that impacted the gross margin just wondering.

How much is left does that carry through the second half or are you kind of reset at this point.

Yes, I think on the on the backlog question.

It's hard for us to peg a number but I will just tell you that there is room to go there. We're still have lead times of certain customers that we need to get better on and the biggest wildcard within any given time period on our backlog is really the powder.

Finishing business that we have where they do book large projects until they are backlog and kind of move around.

Significantly so.

I don't have a number for you but.

I would say that we still got substantial amount that we can take.

Take out of the backlog to get back to a normal.

Our normal I guess customer customer service levels on the inventory front, we have really built up a bunch of inventory over the last couple of years. So as a management team, we want to make a dent into that and we've actually got some initiatives going on in the factories with targets and incentives and things of that nature to pull inventory back.

And.

That's a good thing I think that makes our business more efficient and more effective.

To be a little bit leaner on inventory and obviously the cash flow implications are very nice.

Not doing anything to sacrifice, our ability to deliver product that our customers need.

Really just making sure that when it comes to buying components and being smart about what we do put on the shelf.

That we're doing it with a with a mindful eye. We just went through this period where.

For the last couple of years, it's been it's been crazy.

If you find a component.

You're not just buying the one or two that you need you might buy 10 so.

It's a little bit of a reset there.

It's not going to really impact our ability to deliver the products that our customers need.

Okay and then.

Good color on contractor and the moving pieces and kind of activity, but I'm just trying to.

Think about third quarter, because you have you had tremendous growth there last year.

Just better understanding the moving pieces last year, so we understand maybe the comp dynamics.

Well again, I think that what we have tried to do with our outlook rather than try to nail a quarter is really give our global outlook for the business for the full year.

And we take a hard look at what the order rates look like.

What we've been able to deliver out of the factory reasonable assumptions there.

Some reasonable assumptions on backlog.

<unk> reduction.

And then we also overlay that with the forecast that we get from our business units on what they expect from customers in the marketplace. When we put all of those things together again I think we feel confident in our guide for the full year.

Okay, but within that.

As contractor.

Grow for the year, or obviously processes blowing and going in versus the low single digits.

To just tighten up contractor yes.

Yes, so we don't I don't do we don't do that we are a global revenue outlook.

For the for the full company, we don't give specific.

Revenue outlooks by segment.

Okay.

Thanks, a lot.

Thank you.

And one moment our next question.

And our next question comes from Laurent <unk> from William Blair. Your line is now open.

Hey, Thanks, and good morning.

So you took some price this year earlier in the year can you update us on what your expectation is for the year and your ability you think to drive further price increases and especially with respect to contractor and then into 2024, considering some of the weakness.

Thank you.

Thanks.

Yes. So this year, we did we did increase prices early in the year and some of our segments.

Course, where we're still we haven't lapped some of the larger increases that we did last year in the third quarter. So.

Overall price realization I don't think we have a target for the full year, but I would just tell you it's going to be similar to what you've seen so far this year would be a pretty good a pretty good gauge for you going into next year obviously.

The teams are just starting to look at the data now and in terms of future pricing. We do expect to raise prices again early in 2024, I would expect it to be a more normal year.

What we've seen in the past, but what I will say is that.

Inflationary pressures are still there.

And so it's not like inflation has gone away, yes, it's lower than it was in some of the component shortages are better than they were but we fully expect that.

We will need to move our pricing again in early 2024, yes, I would just add to that asset.

It would be.

Speak for myself as a former field guy it would be our hope my hope.

That will take we.

We will take cost and market conditions into account when we do that and the price adjustments that we would implement at the beginning of the year would be.

In an ideal world from my perspective would be the ones that would be in place for the balance of the year for the reasons that we've talked many times with you over about.

Giving our channel of real good window into their costs as they as they.

However, what we learned last year was with.

The precedent.

That we took then that we.

We will always now and in the future to keep all of our options open.

Yes.

That's great. Thank you for the color and then as it relates to I think you mentioned, maybe new products and process and how do we balance the accretive new products versus.

Startup costs and marketing costs, because I believe you also said that margins and profit for sustainable. So can you just walk us through that a little bit.

Well at any given time in any business unit, we've got new products coming out in different categories and of course, they all have different margin rates, depending upon which business you're in and then of course the level of demand that we get out of product in terms of incremental growth is something that we pay attention to so I think what we've just said publicly is that.

Through a cycle, we expect to grow at about twice what the underlying growth is are the markets that we're in and a big part of that is coming from the new products that we launch not only are we driving new technology and a lot of cases, I've mentioned that the transition from.

Two electric pumps from air pumps Big energy savings.

In addition in addition to.

That we can also realize some pricing and potentially some incremental margin expansion as we're launching new products so that the company.

Has a really nice organic growth profile to it but it's really driven by our engineering teams and our marketing teams identifying the right types of products to launch in every single business unit at Graco has nice.

Robust five year product plans that they're executing.

On a regular basis, so I would like to be able to give you a little bit more.

Clarity, but.

It is a fairly niche complicated business across multiple segments, but I think you should you should know that.

Things are.

We have a lot of good stuff in the pipeline when it comes to our product ideas.

Okay, but I guess, where I was going with it with and whether they would be dilutive at all the margin to process, but you've also noted that those are sustainable so thank you.

Yes.

And thank you and ladies and gentlemen, if you have a question that is star one one again if you have a question that is star one one.

And I am showing no further questions I would now like to turn the conference back to Mark Siegel for closing remarks.

Okay, well. Thank you very much for your participation today on today's call and we hope to see you soon.

This concludes today's conference call. Thank you for participating you may now disconnect.

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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 company website at Www Dot <unk> Dot com.

During this call various remarks may be made by management about their expectations plans and prospects for the future. These.

These remarks constitute forward looking statements for the purpose of the Safe Harbor.

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 2022 annual report on Form 10-K and in item one a.

Of the company's most recently 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.

I'll now turn the conference over to Chris.

Executive Vice President corporate controller.

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

Yesterday, <unk> reported second quarter sales of $560 million, an increase of 2% from the second quarter of last year. The effect of currency translation decreased sales by one percentage point or approximately $3 million reported net earnings increased 14% to 134 million.

For the second quarter diluted net earnings per share was <unk> 78.

An increase of 15% over last year after adjusting for the impact of excess tax benefits from stock option exercises diluted net earnings per share was <unk> 75.

The gross margin rate increased 310 basis points in the quarter strong price realization plus favorable product and channel mix, mainly in the contractor segment was more than enough to offset higher product costs.

Normalized.

Total operating expenses increased $14 million or 12% in the quarter, primarily from rate based increases of $6 million and incremental share based compensation of $4 million.

The adjusted tax rate was 19% for the quarter, which is consistent with our expected full year tax rate of approximately 19% to 20% on an as adjusted basis.

Cash provided by operations totaled $282 million for the year, an increase of $147 million from last year, mostly driven by higher net earnings and a reduction in inventory purchases.

Cash provided by operations as a percent of net earnings is 107% for the year Cigna.

Significant uses of cash year to date, where dividend payments of $79 million and capital expenditures of $92 million we.

We estimate capital expenditures for the year to be $200 million with $130 million related to facility expansion projects. Finally, subsequent to year end or quarter end, we repaid $75 million of our private placement debt, including a prepayment fee of $700000, which will be recognized.

Interest expense in the third quarter of this year.

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

Thank you, Chris and good morning, everybody all of my comments. This morning will be on an organic constant currency basis.

Sales were up 3% for the quarter, we achieved record second quarter revenue and operating earnings driven by strong results in both the process and industrial segments.

Contractor performance remained mixed with growth in pavement protective coatings and spray foam unable to offset softer sales in the home center and pro paint channels.

EMEA was a bright spot during the quarter growing 5% compared to last year with growth in all reportable segments.

Coming order rates in many key product categories have been solid and sales have improved as many of the adverse component and product availability issues that impacted EMEA last year have improved.

Operating margins were strong for the quarter as we continued to benefit from our pricing actions in 2022 and 2023.

Price realization in the businesses and regions accounted for nearly all of our revenue growth and significantly contributed to our companywide incremental margins of 75%.

With similar volumes and costs for the rest of the year, we expect to continue to see solid margin performance for the remainder of 2023.

Our consolidated backlog.

Was $330 million at the end of the quarter down $20 million from the end of last quarter.

Issues with supply chain and component availability have improved modestly.

Better component availability has allowed us to increase our customer service levels, although we still have room for improvement.

Now turning to some commentary on our segments the.

Somewhat offsetting these headwinds were growth in our payment in high performance coatings and spray foam businesses.

New product introductions were also incrementally favorable for both the quarter and on a year to date basis.

We believe that the current inventory levels within the home center channel are reflective of foot traffic in the stores and out the door sales.

The decline in the North America propane channel compares to strong second quarter sales last year, when we made a significant dent in our backlog back orders to key customers after component shortages started to ease.

Growth in EMEA during the quarter was largely due to improved product availability and strong price realization.

Asia Pacific on the other hand declined 6% as the shipping container business and construction markets were weaker than a year ago, especially in China.

The industrial segment grew 4%, resulting in record second quarter revenue and operating earnings active.

Activity in key end markets, such as alternative energy and electronics and battery has been robust.

Incoming orders and our liquid, finishing and sealant and adhesive businesses remained solid but were somewhat offset by continued softer demand in our powder, finishing business, especially in Asia Pacific, However, backlogs and powder equipment and systems remain elevated giving us confidence for a better second half of the year.

The process segment grew sales, 14%, resulting in second quarter records for both revenue and operating earnings.

This is the 10th consecutive quarter that processes set these records.

We saw continued broad based sales growth in all product categories. However, vehicle service automatic lubrication and semiconductor were the key drivers of the impressive performance this quarter.

Steady volume.

Strong pricing and good expense management resulted in incremental margins of 76% for the quarter and operating earnings of 31%, which is another record for the segment.

At similar volumes, we believe the current operating margin rate is sustainable and we are pleased with the strong margin progression that has occurred in this segment the last two years.

Moving to our outlook.

Our results for the first six months were essentially in line with our expectations and market activity can be broadly characterized as having pockets of both strength and weaknesses.

Overall, we're seeing modest sales growth drive strong earnings leverage.

Current order rates, along with elevated backlogs give us confidence that we will attain our full year revenue guide of low single digit organic growth on a constant currency basis.

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

And thank you.

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.

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

And one moment please.

And our first question comes from Deane Dray from RBC capital markets. Your line is now open.

Thank you and good morning, everyone.

Ian.

Okay.

Could you expand on the point on the pro paint.

Channel.

It sounded like there was a lot of.

Backorder inventory that you were finding were able to ship.

Did that have an impact.

This quarter that.

There was more product availability and so forth it just.

It sounded like that that was kind of either like a rubber banding of.

The product going into the channel just some clarity there please.

Yes, I think.

And David and Chris can comment too, but I think what we were trying to highlight was that a year ago.

We had a lot of back orders and we did free up some components in the factory to get product out the door in Q2 that might've been a little bit higher than normal just because we had such a.

A huge amount and so when youre looking at comparison to last year.

That was really why I think we saw a little bit tougher comp.

I would just add this is David I would just add that I think it's also true in the mindset of the buyers in the in the contractor channel generally both propane and home center, we have our most sophisticated point of sale systems and people and a year ago.

<unk>.

Studying our fulfillment rates I think it's safe to conclude and confirm this with our factory people.

Saw it.

Meaningful free up in some of the key components that we're blocking shipments.

Alright, Thats really helpful. And then just to clarify on the home center. It sounds though the Destocking has does that run its course, so sell in versus sell through is now more balanced.

Yes, I think when we talk to the teams that actually are in the field and they are looking at what inventories are in the stores. They feel like right now they are in a good spot.

Given the level of activity that they're seeing in foot traffic and activity within the stores. So.

You never really know Deane right I mean things can change, but at least for now we think that the.

The major home centers are in an inventory level that is acceptable given what they are seeing.

Right and then just lastly on the traffic light slide on it looks as though the.

The Asia.

<unk> have worsened the touch but that was not enough to have you changed the.

Outlook for the year for sales.

Yes.

I think thats accurate I think you've got one thing that when we look at Asia I mean, the majority of it is really the industrial business I mean, we do some we do have CD, it's meaningful but.

When you think about all the activity that's going on in industrial.

With all of the alternative energy stuff.

And if you look outside of China, we saw a nice activity in Korea, Japan, and Southeast Asia and also Australia. So I think we're pretty comfortable with what we've got there.

That's real helpful. Thank you.

Yes.

And thank you.

And one moment our next question.

And our next question comes from Michael Halloran from Baird. Your line is now open.

Hey, good morning, everyone.

Rick.

Or is there some other assumption I should be thinking about.

Yes.

I will just add.

Maybe this is my own. This is my own view that absolutely. We have we have backlog we have back orders and if you think about our segments.

Would say that the process and the industrial segments have backlogs at this juncture elevated to a somewhat higher degree than what we see in contractor my view on the contractor side.

Sure.

I'm reluctant to use the word normal after the experience of the last couple of three years, but in talking with our field people as Mark indicated in our operating people my sense is in the in the major product categories for propane home Center.

And increasingly the protective coating space.

We are enjoying backlogs that are much closer to the historical model than what we've seen anytime since since 2019.

Okay. Thanks for that process side, obviously, the margins have been tremendous.

Can you help a little bit on that.

On the drivers of the strength on the top line side of things.

It's a lot of moving pieces and not a ton of visibility from our side of defense on.

A lot of those moving pieces vehicle services you highlighted it's a strong point.

Seems stronger than the environment would necessarily indicate so if you could just give some more context not just on vehicle services, but all the things going on underneath the hood how much is great.

How much is the market how much is just really dynamic pricing and just give us some more context on that overall picture.

Five years or so so our late night.

Semiconductor business has remained strong.

And the outlook for semiconductor at least next year looks to be fairly good. So thats been a nice development there our environmental businesses.

Where we're moving fluids around in landfills. They are spending more money this year than what we've seen over the last couple of years. So you'll look at the Republic services waste management, they are a little bit more inclined to make investments and so we're realizing some of those benefits lubrication has been a really.

Nice business for us the team there is executing extremely well it's not just the vehicle service side. It's also our industrial lubrication business.

Which competes in about $1 billion revenue market and we are.

Growing nicely in that market by expanding our product line and improving our service levels and hopefully we can continue to.

Yes, Gail OEM presence and drive that business higher I feel like there's a fair amount of runway for growth there that that team has and vehicle service.

All I can tell you is that <unk>.

Dealers make money on getting people into the dealerships and the best way. They can do that is to have you come in for an oil change and when you go in and they want to make sure that the amount of oil that they put in your vehicle is tracked it's monitored and it's put in.

<unk>, we're really excited about it and I know the teams there are executing extremely well.

No that was great last one maybe just talk to what your inventory levels are great because inventory levels are.

And how you see that trending and what it means for cash flow as we look over the next six to 18 months.

I'd like Chris take this one.

So our inventory level currently is pretty flat with where it was.

At the beginning of the year.

We do have some inventory reduction initiatives that are underway, which has started to drive down some of that inventory, especially within the legacy businesses.

I think youll see for the rest of the year, we will continue with less of the inventory purchases as we continue to drive that inventory down too.

A lower level than we've seen historically as we've seen improvements in both the supply chain and product component of our component availability.

Great. Thanks, everybody really appreciate it alright, thanks, Mike.

Thank you.

And one moment our next question.

Okay.

And our next question comes from theory for Jetski from Jefferies. Your line is now open.

Okay.

Hi, good morning.

So I just wanted to focus a little bit more on the margin gross margin step down sequentially. Despite the higher dollar what drove that and Lee with <unk>.

You need to see for margins should accelerate from here.

Well I mean, there is there is a couple of things I think that for sure mix, particularly in contractor.

Wasn't as favorable as it was in Q1 for example, so a little bit higher coming out of the home center as a percentage of their total revenue.

The price realization has been has been good we are offsetting our cost I would tell you that chris's comments upfront about factory volumes.

Being down is something that's putting a little bit of pressure on the gross margin and if you look sequentially at what happened between Q1 and Q2.

Take concerted action to try to pull some of that inventory back and I think you see that showing up on the cash flow statement, where our cash flow is dramatically better than it was last quarter and a year ago. So overall.

Margin rates are decent.

And I feel like we're in a good spot for the rest of the year to maybe put some more points on the board there.

Thanks, and then just.

Not to beat this but on the incremental margins industrial the came in lower than I think we would expect I don't know if thats, what the factory volumes, but.

Does that factory volumes slower growth in APAC or just what drove that.

Yes.

I think that the overall industrial results were down like 100 basis points for the <unk>.

Quarter over quarter, and what I would tell you is that in any 13 week time period, there is going to be some volatility in there I don't think theres any thing systematically different in terms of what's going on in that business than others. So.

Again, I feel like overall absolute levels of profitability. There are really good there might be a little bit of variation from time to time, but but not no problems.

I appreciate the color thanks, Jeff Thanks, Mary Anne.

Thank you.

Yes.

And one moment our next question.

And our next question comes from Matt Summerville from D. A Davidson <unk> company. Your line is now open.

The cycle, if you will and when we look at the second quarter should we consider this to be a new kind of base run rate of business of 140 million you did in the quarter. If I look back. This business has been phenomenal to your 0.7 straight quarters of quarter on quarter growth.

I guess I'm, just trying to get a feel for what the go forward view is relative to this second quarter performance you guys turned in yet.

Because we own the motor technology that goes into that pump and so that is a trend thats going to play out.

For several years and I think we're really really well positioned there.

And also that segment, whether it's in industrial applications or the lubrication applications are at really all the sanitary food.

Food and beverage all of this stuff they get into.

It's probably the most fertile ground for us when it comes to M&A hunting.

And we've built a business there now that I think can be leveraged to the extent that we find attractive targets that we can bolt into the operations there.

Im very pleased with the team we built a new factory Forum last year, they've moved up there it's up in Dayton, I'd encourage anybody to come and visit that wants to see it.

A lot of good things happening in the process.

I appreciate that color and then I just want to put a finer point on contracting to make sure I.

Yes, I think that to the latter question, yes, I think that the inventory levels on the propane side are at a level that is reflective of the business that they are saying both both were down.

In the quarter, so I'd want to sugarcoat that.

But.

Both both pieces of the business.

<unk> and home center were down what I, what I will say is that when we talk to the pro painters and the contractors that are out there doing jobs.

They'll have they still have business.

Still are pretty busy.

And anybody that's involved in commercial is particularly busy these days so.

Despite all of the the potential for Doom and gloom that came along with interest rates going way up and in housing.

Activity slowing down we're hanging in there pretty good and we've got these other nice niches that we're in like line striping and texture and spray foam and protective coatings that.

And that really helped kind of smooth out maybe some of the more volatility they might see in the business as it just relates to residential housing so all in all.

Not too bad.

Should leave well enough alone because I agree with everything and Mark summary, the way I'm thinking of it is certainly when we talk about construction and contractor activity here in North America, the macro data both on the commercial side and frankly on the residential side is coming through stronger and forecasts.

Cash that we've seen as recently as coming through in the last couple of weeks.

At the at the point of sale.

The channel partners.

And our own salespeople.

Their checks really.

For the most part believe that I'll say.

This is what they want wholesale and retail or inventory levels stocking points are in line and I think that this would be this is important because it means if so or if its mostly true.

<unk>.

Thank you guys appreciate the color thanks, Matt.

Thank you.

And one moment our next question.

And our next question comes from Jeff Hammond from Keybanc capital markets. Your line is now open.

Hey, good morning, guys.

Jeff Hey.

Hey, just.

I think you gave a backlog number and said it was down 20 million sequentially I think 330 $330 million just wondering.

What you think is.

More reflective of our normal backlog in.

How long of a period, where we start to where we see these kind of lower orders to get back to normal and then along the same lines. I think you said you are kind of under producing to bring inventories down and that impacted the gross margin just wondering.

How much is left does that carry through the second half or are you kind of reset at this point.

Yes, I think on the on the backlog question.

It's hard for us to peg a number but I will just tell you that there is room to go there. We are still have lead times of certain customers that we need to get better on and the biggest wildcard within any given time period on our backlog is really the powder.

Finishing business that we have where they do book large projects until they are backlog and kind of move around.

Significantly so I.

I don't have a number for you but.

I would say that we still got substantial amount that we can take.

Take out of the backlog to get back to a normal.

Incentives and things of that nature to pull inventory back in.

That's a good thing I think that makes our business more efficient and more effective.

To be a little bit leaner on inventory and obviously the cash flow implications are very nice.

Not doing anything to sacrifice, our ability to deliver product that our customers need.

Really just making sure that when it comes to buying components and being smart about what we do put on the shelf.

That we're doing it with a with a mindful eye. We just went through this period where.

For the last couple of years, it's been it's been crazy.

If you find a component.

You're not just buying the one or two that you need you might buy 10 so.

It's a little bit of a reset there.

It's not going to really impact our ability to deliver the products that our customers need.

Okay and then.

Good color on contractor and the moving pieces and kind of activity, but I'm just trying to.

Think about third quarter, because you have you had tremendous growth there last year and just better understanding the moving pieces last year. So we understand maybe the comp dynamics.

Well again, I think that what we have tried to do with our outlook rather than try to nail a quarter is really give our global outlook for the business for the full year.

And we take a hard look at what the order rates look like.

What we've been able to deliver out of the factory reasonable assumptions there.

Some reasonable assumptions on backlog.

Reduction.

And then we also overlay that with the forecast that we get from our business units on what they expect from customers in the marketplace. When we put all of those things. The other again I think we feel confident in our guide for the full year.

Okay, but within that.

As contractor.

Grow for the year, or obviously processes blowing and going in versus the low single digits.

To tighten up contractor.

Yes, so we don't I don't do we don't do that we give a global revenue outlook.

For the for the full company, we don't give specific.

Revenue outlooks by segment.

Okay.

Thanks, a lot.

Thank you.

And one moment our next question.

And our next question comes from Laurent <unk> from William Blair. Your line is now open.

Hey, Thanks, and good morning.

Thanks.

Yes. So this year, we did we did increase prices early in the year and some of our segments.

Of course, where we're still.

Haven't lapped some of the larger increases that we did last year in the third quarter. So.

The teams are just starting to look at the data now and in terms of future pricing. We do expect to raise prices again early in 2024, I would expect it to be a more normal year than what we've seen in the past, but what I will say is that.

Inflationary pressures are still there.

And so it's not like inflation has gone away, yes, it's lower than it was in some of the component shortages are better than they were but.

We fully expect that.

We will need to move our pricing again in early 2024, yes, I would just add to that asset.

It would be.

Speak for myself as a form of field Guy it would be our hope my hope.

That will take we.

We will take our cost and market conditions into account when we do that and the price adjustments that we would implement at the beginning of the year would be in.

In an ideal world from my perspective would be the ones that would be in place for the balance of the year for the reasons that we've talked many times with you over about.

Giving our channel of real good window into their costs as they as they.

However, what we learned last year was with.

The precedent.

That we took then that.

We will always now and in the future and keep all of our options open.

Yes.

That's great. Thank you for the color and then as it relates to I think you mentioned, maybe new products and process and how do we balance the accretive new products versus maybe not.

Startup costs and marketing costs, because I believe you also said that margins and profit for sustainable. So can you just walk us through that a little bit.

Well at any given time in any business unit, we've got new products coming out in different categories and of course, they all have different margin rates, depending upon which business. You are in and then of course the level of demand that we get out of our product and in terms of incremental growth is something that we pay attention to so I think what we've just said publicly is that.

Two electric pumps from air pumps Big energy savings.

But in addition in addition to.

That we can also realize some pricing and potentially some incremental margin expansion as we're launching new products so that the company.

It has a really nice organic growth profile to it but it is really driven by our engineering teams and our marketing teams identifying the right types of products to launch in every single business unit at Graco has nice.

Robust five year product plans that they're executing.

On a regular basis, so I would like to be able to give you a little bit more.

Clarity, but.

It is a fairly niche complicated business across multiple segments, but I think you should you should know that.

Things are.

We have a lot of good stuff in the pipeline when it comes to our product ideas.

Okay, but I guess, what I was going with it with and whether they would be dilutive at all the margins of process, but you've also noted that those are sustainable so.

Thank you.

Yes.

Thank you.

And ladies and gentlemen, if you have a question that is star one one again if you have a question that is star one one.

And I am showing no further questions I would now like to turn the conference back to Mark <unk> for.

Okay.

Okay, well. Thank you very much for your participation today on today's call and we hope to see you soon.

This concludes today's conference call. Thank you for participating you may now disconnect.

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