Graco Inc.

Good morning and welcome to the fourth 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 in the United States or Canada. The dialing number for international callers is 404-537-3406. The conference ID number is 7385629. The replay will be available through 2 p.m. Eastern Time, Tuesday, February 8, 2022. 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 2020 annual report on Form 10-K and in Item 1-A of the company's most recent quarterly report on Form 10-Q. These reports are available on the company's website at www.brayco.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 Kathy Schoenrock, Executive Vice President, Corporate Controller and Information Systems.

Good morning. I'm here today with Mark Sheehan and David Lowe. I will provide a brief overview of our quarterly results before turning the call over to Mark for further discussion. Our conference call slides have been posted on our website and provide additional information that you may find helpful. Yesterday, Graco reported fourth quarter sales of $540 million, an increase of 15% from the fourth quarter of last year. As a reminder, the fourth quarter of 2021 included 14 weeks as compared to 13 weeks in 2020. The effects of currency translation rates and acquisitions did not have a meaningful impact on worldwide sales for the quarter. Reported net earnings were $120 million for the fourth quarter, or 69 cents per diluted share. After adjusting for the impact of the pension settlement loss, excess tax benefits from stock option exercises, and certain non-recurring tax benefits, Net earnings were $116 million, or 66 cents per diluted share. Gross margin rate was down 120 basis points from the fourth quarter of last year, as the favorable effects of product and channel mix, realized pricing, and increased factory volume were not enough to offset the impact of higher product costs. These higher product costs, such as material, labor, and freight, decreased our gross profit by $16 million in the quarter and $40 million for the full year. For the contractor segment, higher product costs were $11 million for the quarter and $29 million for the full year. The increase in costs ramped up as the year progressed, with the majority of the cost increases occurring in the second half. We expect to face similar cost headwinds in the first half of 2022. Supply chain constraints, such as logistics capacity and component availability, continue to have an unfavorable impact on our factories' ability to deliver in the quarter and will persist into 2022. Operating expenses increased 17 million, or 15%, in the quarter, mainly due to the increased activity as pandemic-related restrictions eased compared to a year ago. Higher sales and earnings-based expenses also contributed $4 million in additional expense in the quarter. The adjusted tax rate for the quarter was 18%. Cash flows from operations are $457 million for the year compared to $394 million last year. The increase is due to the improvement in earnings partially offset by higher working capital that reflects growth in business activities. Significant uses of cash are capital expenditures of $134 million, including $71 million for facility expansion projects, dividend payments of $127 million, and a voluntary contribution to our U.S. pension plan of $20 million. During the fourth 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. In connection with the transfer, we recognize the non-cash pre-tax pension settlement charge of approximately $12 million in other non-operating expense in the quarter. A few comments as we look forward to 2022. In January, we repaid $75 million of our private placement debt and a $3.5 million prepayment fee. which will be recognized as interest expense in the first quarter of 2022. Based on current exchange rates and the same volume and mix of products and sales by currency, the effect of exchange would have an unfavorable impact of 1% on sales and 3% on earnings for the year. Unallocated corporate expenses are projected to be 28 to 30 million and can vary by quarter. The effective tax rate for 2022 is expected to be 18 to 19%. Capital expenditures are estimated to be $190 million, including $140 million for facility expansion projects at our Minnesota, Sioux Falls, Switzerland, and Romania locations. We may make share repurchases in 2022 via opportunistic open market transactions or short-dated accelerated share repurchase programs. I'll turn the call over to Mark now for further comments.

Thank you, Kathy, and good morning, everyone. All of my comments this morning will be on an organic, constant currency basis. We finished the year strong with record sales in all reportable regions and segments, with the exception of the contractor segment, which achieved its quarterly record earlier this year. We also exceeded our peak annual revenue by $334 million and peak annual operating earnings by $95 million, both previously set in 2018. Consistent with much of 2021, incoming orders exceeded deliveries in the fourth quarter. Again, this was primarily driven by shortages in key materials and components. Some items worth mentioning include electronic components, castings, engines, motors, and raw materials. We are also experiencing unprecedented backlogs at subcontractors who are flooded with demand from customers, including Graco. At the end of the fourth quarter, our consolidated backlog was approximately $375 million, which is $95 million higher than what it was at the end of the third quarter and $220 million higher than than at the end of last year. The full year growth in backlog alone represents more than 10% of our 2021 annual revenue. Our price increase for 2022 will be implemented in the first quarter. However, due to the size of our backlog, we may not begin to fully realize the impact of the increase until the second quarter. We anticipate that our pricing actions will be enough to offset current cost pressures from inflation. Now turning to some commentary on our segments. We have completed the move of our high-performance coatings and foam products from the industrial segment to contractor. This transfer better aligns our contractor-focused businesses with and addresses any overlap we had in markets, products, end users, and distributors. The teams are energized and looking forward to the benefits of the new organization. The contractor segment rebounded in the fourth quarter, growing at high single digits, and ended up the year up mid-teens off tough comparisons to the prior year. The global construction and home improvement markets remain strong with new housing starts, commercial spending, and remodeling activity all expected to grow this year. Incoming order rates have reflected this strength, resulting in a backlog of $64 million, which is up $18 million from the end of the third quarter and up $38 million from the same period last year. Out-the-door sales at our major distributors are robust and we are optimistic that this pace of business will continue. Strong industrial segment performance continued with its fourth consecutive quarter of double-digit growth. The segment grew low teens for the quarter and achieved both quarterly and annual records for sales and operating earnings. Consistent with our other businesses, The biggest challenge is overcoming supply chain constraints that have contributed to a spike in backlog of $92 million compared to the same time last year. Overall, our key end markets remain healthy, with specific strength in automotive, electronics, alternative energy, battery, and agriculture. Process segment sales grew 35 percent for the quarter, resulting in both quarterly and annual records for revenue and operating earnings. This segment was slower to recover than our other segments. However, we are seeing strong demand worldwide in our lubrication, process pump, and semiconductor businesses. We're expecting this recovery to continue in 2022. Moving on to our outlook. Overall, the business is performing well. new product pipelines are robust, and worldwide demand levels remain solid. As a result, we are initiating revenue guidance for the full year 2022 of high single digits on an organic constant currency basis, with growth expected in every region and reportable segment. This guidance is based on the assumption that approximately two-thirds of the growth will come from our pricing actions and the remainder a result of our core strategic initiatives. While we expect to face headwinds in 2022, we believe the strength of our markets, product lines, operations, and people position us well to deliver another year of record sales and earnings. In closing, I want to say thank you again to all of our employees, our suppliers, distributor partners, and end users for another great year. Operator, we're ready for questions.