Graco Inc. (NYSE:GGG) Q3 2023 Earnings Call Transcript

Graco Inc. (NYSE:GGG) Q3 2023 Earnings Call Transcript October 26, 2023

Operator: Good morning, and welcome to the Third Quarter Conference Call for Graco Inc. If you wish to access the replay for this call, you may do so by visiting the company’s website at www.graco.com. Graco has additional information available in the 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 purpose 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 the Item 1A of the company’s 2022 annual report on Form 10-K and in the 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 Knuston, 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 discussion. Yesterday, Graco reported third quarter sales of $540 million, a decrease of 1% from the third quarter of last year. The effect of currency translation increased sales by 1 percentage point or approximately $5 million. Based on current exchange rates, currency translation should have no effect on full year net sales and an unfavorable impact of approximately 1 percentage point on net earnings for the full year. Reported net earnings increased 15% to $133 million for the quarter.

Diluted net earnings per share was $0.77, an increase of 15% over last year. During the quarter, we recognized a noncash goodwill impairment charge of $8 million and a $9 million gain from the reduction in the fair value of contingent consideration, related to the reorganization of a business acquired in 2020. Both of these items were included in unallocated operating expense. Excluding the impairment charge, contingent consideration adjustment and tax benefits from stock option exercises, adjusted net earnings per share was $0.76. The gross margin rate increased 490 basis points in the quarter. Strong price realization and lower product costs were more than enough to offset lower factory volumes. While material costs have somewhat moderated compared to what we experienced last year, lower factory volumes and increased operational spending continue to be headwinds for the quarter and year-to-date.

Total operating expenses increased $3 million or 3% in the quarter, primarily from volume and rate-related increases of $1 million and incremental share-based compensation of $2 million. Gross margin rate improvement more than offset these increased operating expenses during the quarter, resulting in operating margin rate growth of 4 percentage points. Contractor operating margins increased 5 percentage points to 30% and Process operating margins increased 7 percentage points to 31% compared to the third quarter last year. At current volumes, we believe these operating margin rates are sustainable for the remainder of the year. Nonoperating expenses decreased $2 million as a result of increased interest income on cash held. The adjusted effective 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 $491 million for the year-to-date. An increase of $219 million from last year, mostly driven by higher net earnings and a reduction in inventory purchases. Cash provided by operations as a percentage of net earnings is 124% for the year. Through the end of the quarter, we repurchased 427,000 shares for $31 million. We have continued to repurchase shares in the first week of October. And as of market close yesterday, we have repurchased 1.3 million shares for $93 million year-to-date. During the quarter, we repaid $75 million in private placement notes plus a prepayment fee of $700,000. This represented the final series of the private placement debt we entered into in 2012. We also made year-to-date dividend payments of $119 million and capital expenditures of $146 million with $89 million related to facility expansion projects.

Finally, our full year estimates for unallocated corporate expense and capital expenditures can be found in the conference call slide deck on Page 10. I’ll now turn the call over to Mark for further segment and regional commentary.

Mark Sheahan: Thank you, Chris. Good morning, everybody. All of my comments this morning will be on an organic constant currency basis. In the face of a modest 2% revenue decline, we reported record third quarter operating earnings and operating profit margin. We experienced another quarter of strong broad-based sales growth in the Process segment, which was up 9% and 13% for the quarter and year, respectively. The Industrial segment was down slightly on lower project activity in our Gema Powder business, and our Contractor segment declined 8% from a combination of a difficult comparison in EMEA versus last year’s record quarter and the softening of global construction markets. Overall, we’re pleased that the company achieved third quarter operating margins of 30% or more in each of our segments.

This was driven by a significant growth from the Process segment, coupled with strong operating performance from both Industrial and Contractor. Realized pricing actions remained strong and our factories have rebounded nicely after a couple of tough years of getting product out the door. Input costs remain elevated, but in general, commodity prices have stabilized and should provide less of a headwind for the remainder of the year. At the close of the quarter, our consolidated backlog was $300 million. A decrease of $30 million from the previous quarter and $55 million lower than at the beginning of the year. Backlogs have returned to normal levels within contractor but they remain slightly elevated in semiconductor products and our Gema Powder business.

Now turning to some commentary on our segments and regions. Contractor segment sales were down 8% for the quarter. Sales decline across all regions with the steepest contraction on a percentage basis being in EMEA. EMEA’s results for the quarter were impacted by challenging year-over-year comparisons. In 2022, Contractor sales in EMEA were up 12% in the third quarter, as we were able to ship a considerable amount of our backlog, when supply chain constraints started to alleviate. There is also a robust order activity in the third quarter of 2022 in advance of our October price increase. In Asia Pacific, strong growth outside of China was not enough to offset declines in China from weaker container and construction markets this year. New product introductions and Contractor have helped drive incremental revenue in a challenging macro environment.

Products like our new lightweight QuickShot, electric-powered architectural coatings gun package, and the reactor 2 component proportioning system for spray foam and polyurea applications, have been well received by customers globally. Profitability has improved in Contractor, as pricing actions are now starting to offset the significant cost increases experienced in the last 2 years. And product mix is more favorable than it was a year ago. Industrial segment sales declined 1%. Strong sales in Asia Pacific were offset by timing of project completion and acceptance in our Powder Coating business. activity in key end markets such as alternative energy, electronics and battery has been good. Elevated backlogs are expected to decrease, as we work our way through the fourth quarter.

The Process segment grew 9% in the third quarter. Increases were posted in most business units and across all reportable regions, led by double-digit growth in vehicle services and semiconductor. Resilient volume, strong pricing and good expense management drove incremental margins of 102% for the quarter and operating earnings of 31%. Our lubrication equipment, diaphram pumps, semiconductor equipment and environmental equipment businesses all posted revenue gains in the third quarter and for the year. We’ve been able to leverage this growth into record operating profit margins for this segment this year. Moving to our outlook. Our sales results for the first 9 months were in line with our annual — our annual guide of low single digits organic growth on a constant currency basis.

While macroeconomic conditions worldwide are unpredictable and business tempo has slowed from a year ago, we’re pleased with the improvements that we are making in the business and that are driving record levels of profitability. Current order rates, along with backlogs, new product activity and strong pricing gives us confidence that we will attain our full year 2023 revenue guide. That concludes our prepared remarks. Operator, we’re ready for questions.

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Q&A Session

Operator: [Operator Instructions]. Our first question comes from Mike Halloran with Robert W. Baird.

Unidentified Analyst: It’s Pan on for Mike today. I know that we — I know we picked it this last quarter, but I’m going to take another stab at it. Obviously, Process has been a bright spot in the portfolio, both from a top line and a margin perspective. But can you maybe dig in about why the sustainability of demand has been so good, particularly why lubrication and vehicle services continue to be so strong? And then additionally, I know you mentioned that backlog in semi continues to be good. Can you maybe talk about why you’re seeing maybe more sustainable trends versus some of the broader — maybe your broader peers in the semi space recognizing that your offering is a little bit different using peers very loosely there?

Mark Sheahan: Yes, sure. I’ll take a stab at it. I mean a couple of things. Obviously, we did some nice pricing actions over the last, I don’t know, 18 months or so, which I think we’re still seeing the benefit of. So when you look at our headline numbers, the revenue growth does have pricing baked into it. Notwithstanding that, though, when you look across the portfolio of things that we have in that segment, whether it’s our diaphragm pump business, where we’ve got some really good new products that are contributing to the growth. In semiconductor, we have been working down back orders throughout the year, which were actually embarrassingly high a year ago, and the team has done a really nice job of getting some throughput in the factory and making a lot of efficiency improvements there.

The outlook for semiconductor this year wasn’t so good, and I think our orders are kind of falling in line with that. But as you look into ’24 and into ’25, there is a lot of investment going on there. And so we feel like this is a good catch-up year for us. And hopefully, business remains robust, as we kind of work our way through the backlog we’ve got left. And then as we roll into 2025. Vehicle service team is just doing really well in Lubrication overall. Of course, we got VS, but we also have industrial lube and we’re seeing decent growth in both of those categories. It’s a combination of superior execution, the ability to deliver out of the factory, some new product launches, that we’ve had that have really taken a nice hold in the marketplace.

And that’s and combined with the pricing actions they’ve done and watching expenses, they’ve really been able to drive profitability at an extremely high rate there. Our environmental businesses are doing well. Of course, the QED business, where we manage the fluids in and around landfills. And also the Gas Analyzer business that we have that does that analyzes the methane gas that’s coming off of the landfills. It seems like after a couple of years where the big players in landfill weren’t making investments. They have started to pick up a little bit there. And so we’ve got a great product line, and I think we’re benefiting there. We have a strong team, good factory performance. I think that it’s a combination of pricing, great execution in the factories, some nice new product launches and reduction of backlog, that’s really driven our results this year.

Unidentified Analyst: That’s really robust answer. Super helpful, Mark. And maybe switching gears a little bit. Obviously, Inga has been with the team now for a little bit of time. I know that working on M&A and building that pipeline has been a priority. Could you maybe comment on the progress with building that pipeline whether you feel like you’re getting the appropriate traction and where you need to be? Any color on the pipeline development and kind of the process would be helpful.