Graco Inc.

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 dialing 1-855-859-2056 within the United States or Canada. The dialing number for international callers is 404-537-3406. The conference ID number is 925-1859. The replay will be available through 2 p.m. Eastern Time Thursday, October 28, 2021. RICO 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 2020 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 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 Schoenrock, Executive Vice President, Corporate Controller.

Good morning, everyone. I'm here this morning with Mark Sheehan and David Lowe. I will provide a brief overview of our quarterly results before turning the call over to Mark for additional discussion. Our conference call slides and our third quarter form 10Q are on our website and provide additional information that you may find helpful. Yesterday, Graco reported third quarter sales of $487 million, an increase of 11% from the third quarter of last year. The effect of currency translation added two percentage points of growth, or approximately $6 million in the quarter. Reported net earnings were $104 million for the third quarter, or $0.59 per diluted share. After adjusting for the impact of excess tax benefits from stock option exercises and certain non-recurring tax adjustments, net earnings were $100 million or $0.57 per diluted share. Gross margin was down 110 basis points from the third quarter of last year as a favorable effect from realized pricing, increased factory volume, and currency translation were not enough to offset the unfavorable gross margin rate impact of higher product costs. These higher product costs, such as material, labor, and freight, decreased our gross profit by $14 million in the quarter, with $10 million of this impacting the contractor segment. At current costs and volumes, we estimate that on a dollar basis, realized price and increased factory volumes will offset higher product costs for the full year. However, these costs will continue to be decremental to the gross margin rate. Supply chain constraints such as logistics capacity and component availability also had an unfavorable impact on our factory's ability to deliver in the quarter and will likely persist for the remainder of the year. These challenges were predominantly felt in the contractor segment as this is our highest volume business. Operating expenses increased 20 million or 19% in the quarter. Sales and volume-based expenses increased $9 million, new product spending increased $2 million, and changes in currency translation rates increased operating expense by $1 million in the third quarter. The adjusted tax rate for the quarter was 18%. Cash flows from operations are $357 million for the year compared to $263 million last year. This increase is due to the improvement in earnings, partially offset by increases in working capital that reflect the growth in business activity. Significant uses of cash are dividend payments of $95 million and capital expenditures of $83 million, including $33 million for facility expansion projects. A few comments as we look forward to the fourth quarter. Subsequent to the end of the third quarter, Graco entered into an agreement in which approximately $63 million of pension obligations were transferred to an insurance company through the purchase of an annuity contract. The annuity contract purchase will be funded with existing plan assets. This arrangement is part of the company's effort to reduce the overall size and volatility of its pension plan obligations. We expect to recognize a non-cash pre-tax pension settlement charge of approximately $12 million in other non-operating expense in the fourth quarter. Based on current exchange rates, The full year favorable effect of currency translation is estimated to be 2% on sales and 4% on earnings, with the most significant impact having occurred in the first half of the year. Also, for the remainder of 2021, we expect unallocated corporate expense to be approximately $26 to $28 million. The decrease from prior estimates is due to lower stock compensation expense for the year. Our full year adjusted tax rate is expected to be 18% to 19%. Capital expenditures are estimated to be $150 million, including $80 million for facility expansion projects. Finally, 2021 will be a 53-week year with the extra week occurring in the fourth quarter. I'll turn the call over to Mark now for further segment and regional discussion.

Thank you, Kathy, and good morning, everyone. All of my comments this morning will be on an organic constant currency basis. Sales in the third quarter grew high single digits driven by the continued recovery in both our industrial and process segments. Contractor North America had difficult comparisons from last year's record third quarter. Contractor demand was solid in Europe and Asia with double digit gains in both regions. Heading into the fourth quarter, business remains robust. For the first three weeks of October, our global orders continued to outpace billings in all three segments. Normally, we don't talk about backlog since most of our business is book and ship. However, given the current environment, which is rife with component shortages and logistical disruptions, backlogs are worth mentioning. At the end of the third quarter, our consolidated backlog was approximately $280 million. which is $25 million higher than what it was at the end of the second quarter and $121 million higher than our backlog at the end of last year. Orders are abundant. However, our biggest challenge is getting the materials and components we need and then navigating the logistical challenges inherent in today's environment. We expect conditions to remain this way for a while. And there is nothing unique to what Graco is experiencing when it comes to these issues. One more thing before commenting on our segments. It's anticipated that our planned pricing actions in 2022 will be enough to fully offset current cost pressures. Our annual pricing cadence has been appreciated by our channel partners and has tangible commercial value in the marketplace. Now turning to some commentary on our segments. I'll start with contractor equipment. The residential construction and home improvement markets remain strong globally. On a dollar basis, incoming order rates have been relatively stable and overall demand has exceeded our expectations given the surge that we experienced last year. Contractor backlogs are elevated at $46 million, which is up $6 million from June and up $22 million from the same time last year. The overall pace of business, including out-the-door sales, is robust. The industrial segment grew at high teens for the quarter, with year-to-date sales exceeding previous highs set in 2018. We experienced broad-based growth in all major end markets and reportable regions, which is a nice bounce back from what we faced a year ago. Consistent with our other businesses, The biggest challenge in this segment is getting product out the door. And user demand is very strong, and we anticipate this to continue for the balance of the year. Process segment sales grew 21% for the quarter, with year-to-date sales exceeding previous highs set in 2019. Similar to industrial, broad-based growth continues in all major end markets and reportable regions. The recovery of both our lubrication and process pump businesses drove sales and earnings growth for the quarter in the segment. Moving to our outlook. With demand persisting, we confirm our full year outlook of mid to high teen organic revenue growth on a constant currency basis for the full year 2021. While we expect continued headwinds from raw material costs, logistics, component availability in the fourth quarter, We believe we are positioned to deliver a record year. In closing, I'd like to thank all of our employees, suppliers, and distributive partners who continue to work hard, keeping up with customer demand in this challenging operating environment. Shannon, we're ready for questions.