Graco Inc. (NYSE:GGG) Q1 2024 Earnings Call Transcript

Graco Inc. (NYSE:GGG) Q1 2024 Earnings Call Transcript April 25, 2024

Graco Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the First 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.graco.com. Graco 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 1A of the company’s 2023 Annual Report on Form 10-K and in Item 1A of the company’s most recent quarterly report on Form 10-Q.

These reports are available on the company’s website at www.graco.com and the SEC’s website at www.sec.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 Chris Knutson, Executive Vice President, Corporate Controller.

Christopher Knutson: 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 commentary. Yesterday, Graco reported first quarter sales of $492 million, a decrease of 7% from the first quarter of last year. Reported net earnings decreased 5% to $122 million or $0.71 per diluted share. Excluding the impact of excess tax benefits from stock option exercises, adjusted non-GAAP net earnings were $113 million or $0.65 per diluted share, a decrease of 12%. The effect of currency translation had no significant impact on sales or net earnings for the quarter. The gross margin rate increased 30 basis points in the quarter.

Strong price realization and lower product costs were more than enough to offset unfavorable product and channel mix from the Industrial and Contractor segments. Total operating expenses increased $5 million or 4% in the quarter, mainly due to higher stock-based compensation and additional investment in new product development. Gross margin rate improvement was not enough to offset sales volume declines and increased operating expenses during the quarter, resulting in operating margin rate decline of 260 basis points. Interest and other expenses decreased $7 million during the quarter, driven primarily by higher interest income on cash held and lower interest expense as our long-term debt was repaid in 2023. The adjusted effective tax rate was 19.8%, which is consistent with our expected full year tax rate of approximately 19.5% to 20.5% on an as-adjusted basis.

Cash provided by operations totaled $119 million, an increase of $28 million from last year, driven mostly by favorable changes in working capital items, more than offsetting lower net earnings. Cash provided by operations as a percent of adjusted net earnings was 105%. Significant year-to-date uses of cash include dividends of $43 million and capital expenditures of $37 million, including $30 million of facility expansion projects. These cash uses were offset by share issuances of $41 million. A few comments as we look forward to the rest of the year. Based on current exchange rates, assuming the same volumes, mix of products and mix of business by currency as in 2023, movement in foreign currencies would have no impact on net sales, and a 1 percentage point unfavorable impact on net earnings for the full year.

Finally, our full year estimates for unallocated corporate expense and capital expenditures remain unchanged and can be found in the conference call slide deck on Page 9. I’ll now turn the call over to Mark for further segment and regional commentary.

Mark Sheahan: Thank you, Chris. Good morning, everyone. All of my comments this morning will be on an organic constant currency basis. We began the year softer than expected with revenue declines across all segments, driven by weakness in semiconductor, process transfer equipment, liquid finishing, and sealant and adhesive systems sales. Contractor North America also started the year slow, but as the quarter progressed, our incoming order rates improved. Despite these challenges, both our lubrication and powder equipment finishing systems grew during the quarter. And regionally, EMEA Contractor improved with robust sales in spray foam and protective coatings, along with an improved Pro paint channel. Volume declines put some pressure on margins in the quarter, but we were happy with the resilience in our gross margin rate, reflecting positive price/cost relationships, while maintaining operating margins for each segment at or greater than 29%.

At the end of the quarter, our consolidated backlog was $285 million, which is $5 million higher than at the beginning of the year, but was $65 million below the first quarter of last year. The increase resulted from the improving incoming order trends we saw at the end of the quarter, which have extended into April. Now turning to some commentary about our segments. The Contractor segment was down 6% against a strong first quarter comp last year. EMEA was a bright spot with strong Pro paint, spray foam and protective coatings markets. North America was heavily impacted by the timing of this year’s new product releases, which will primarily be in the second quarter. Feedback from the channel has been positive, and we’re excited to start shipping orders of these products as they’re fully released.

Incoming order rates steadily improved as the quarter progressed, which gives us optimism that we can rebound from the soft start and see some growth. Backlog was up $10 million compared to the end of last year. Operating margins held up at 29% despite the lower sales volumes. The Industrial segment declined 5% during the quarter. We continue to have weakness in the Asia Pacific construction markets and had a slow start globally in the liquid finishing and sealant and adhesive systems businesses. Powder coatings systems sales were strong, but were not enough to offset these declines. The battery, alternative energy, packaging and e-mobility markets remain positive, and we have generally seen good coating activity in our key end markets. Operating margins were impacted by the overall decrease in sales volume, revenue mix and higher product development spending.

Moving to the Process segment. Sales were down 10% compared to the same quarter last year. This segment is coming off of three years of strong results with broad-based growth across all product categories. During this period, operating earnings grew from 21% in the first quarter of 2020 to 29% this quarter despite the softer sales volume. We continue to see growth in the quarter for the lubrication business, but that was more than offset by a decline in both semiconductor and process transfer equipment sales. Our semiconductor backlog is decent as we did see order rates improve as we exited the quarter and into the first few weeks of April. We are experiencing shipping delays of products headed into China due to enhanced license requirements.

While order rates have improved, we do expect continued headwinds in semiconductor products for the remainder of the year. Moving to our outlook. January and February bookings were lower than the same period last year. However, bookings for March and the first three weeks of April are up nicely, resulting in flat year-to-date orders. This supports our outlook despite the 7% revenue decline in the quarter. In addition, our new products, especially in Contractor, are exciting and should provide incremental sales when compared to 2023. Our teams are fully engaged and remain focused on delivering another year of growth in sales and earnings. We are reaffirming our full year revenue guidance of low single-digit growth on an organic constant currency basis.

That concludes the prepared remarks. I’ll turn it over for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from Deane Dray with RBC Capital Markets. You may proceed.

Deane Dray : Thank you. Good morning, everyone. I appreciate the prepared remarks. You touched on the quarterly progression, which improved throughout the quarter and by month. So maybe kind of give us some color there. And you tied that to your confidence in being able to reaffirm the guidance. So just take us through the context of that progression. How much can the new products contribute in the second quarter? And then just maybe David has got some comments on this. Having — despite that falloff, that gross margin was actually up, is really encouraging. So give us some context there. Thanks.

Mark Sheahan: Yes, I’ll start and let David chime in on the margin, or Chris as well. Obviously, we had a slow start to the year. January bookings were down. February bookings were down. March, we saw a little bit of a pickup, so we’re in positive territory in March. And here, at least for the first few weeks of April, we’re up very nicely. So as I said in the opening comments, even though we’re down 7% in terms of our revenue, our orders in-house through the end of last week are actually flat with last year. The products are pretty exciting in CED. I’ve been around here for a long time, 29 years. I don’t really remember a time when we were as excited about the releases that we got coming out this year. Maybe when we went into the Home Center in the early 2000s, would be another time when there was a lot of excitement.

But we’re really encouraged by some of the feedback that we’ve gotten from customers in a couple of different areas. You might remember, last year, we launched a product called QuickShot. And it was a gun that was actually solenoid and electronically activated versus a mechanical activated gun that’s pretty common in the airless equipment industry. QuickShot, I think we did tens of millions of dollars of revenue last year with that product. And we’re now taking that technology, and we’re going to run it through our entire airless line, and it’s also compatible with all of our competitors’ airless equipment as well. So if a contractor wants to have the performance of QuickShot, they’re going to be able to have that for their — with whatever kind of airless equipment they have.

Of course, we hope it’s Graco. We’ve also launched a whole new line of electric motors in CED that are in our products that are quieter and they have higher performance than motors that we had previously. These are Graco designed and manufactured motors. They’re specifically designed in manufacturing for airless painting, and nobody else in the world has those. And the feedback has been really good. A couple of really cool new products coming on in the flooring area, where in the past people would be mixing with — in the buckets and then putting stuff on the floor. We’ve got units now that are going to be doing that on the fly with variable ratio. And feedback from our channel partners has been really positive. So I really feel very good about the traction that we hope to see on the new product side.

Of course, the economy is always a bit of a wildcard. But even if the economy is a little bit sluggish in homebuilding and some of the contractor markets, these are going to be great products for many, many years to come. David, I’ll let you talk about the gross margins.

David Lowe: All right. Thank you. I appreciate the opportunity to comment on the gross margin because the premise of the question, I was struck by some of the same — by the results, we’re in a pretty significant — in a softer environment than we had expected going into the year, gross and operating margins by segment held up pretty well. And price realization has played a role across the business units. Units have done a good — the segments have done a good job on price. And probably more importantly, both price and cost dynamics were favorable for the quarter across the business segments. And I — we have to go back a long time before I could make a claim like that. So profitability across those units did hold up. The segments did hold up pretty well.

And I remain hopeful that we’re going to see, certainly on the pricing side, continued respectable realization. And we track our input costs carefully. And at the moment, while they still remain elevated, in several cases they have come off peak.

Deane Dray : That’s really helpful. And I realize I had asked a multipart first question, so I’ll just keep my follow-up very specific. Which of the end markets, the positive and the negative, were the biggest swing factors? So just — I think semiconductor, it sounded like, was one of the negatives. But what would you be highlighting?

Mark Sheahan: Well, I think for the quarter, and really for the year, we anticipated a pullback in semiconductor, which kind of tracks the industry. You might remember, over the last couple of years, we had a bunch of orders or a lot of backlog. And we’ve worked off a lot of that. I think we still have some backlog, but it’s not where it was before. The pundits are all predicting that it’s going to pick up in the latter half of the year, I guess we’ll see. But that one really wasn’t unexpected. I would say that the weakness in the process transfer pumps and some of our industrial equipment markets, at least to start the year, were below what we had expected them to be. And as we kind of wrapped up the quarter into April, it does look like we’re starting to see a little bit of green shoots there in both of those camps.

David Lowe: Maybe I would just add a couple of other segments that people have touched on as being — having some respectable momentum. I know you like industry references. Here in North America, some of our salespeople have cited activity and projects coming down the pike in defense and on the solar side. And our Europe, Middle East team has also called out good project activity, especially in the protective coating space. And of course, the underlying stability in the price of oil probably helps demand in that market.

Operator: Our next question comes from Mike Halloran with Baird.