Graco Inc.

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 dialing 1-855-859-2056 within the United States or Canada. The dial-in number for international callers is 404-537-3406. The conference ID number is 2464642. The replay will be available through 2 p.m. Eastern Time Thursday, May 5, 2022. Graco has additional information available in a PowerPoint slide presentation, which is available as part of the webcast player. As a 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 Security 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 2021 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 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.

Thank you, and good morning, everyone. 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 additional discussion. Our conference call slides have been posted on our website and provide additional information that you may find helpful. Beginning this quarter, our high-performance coatings and foam product offerings historically included within the industrial segment, were realigned and are now managed and reported under the contractor segment. The change will allow business leadership to address the overlap in markets, products, end users, and distributors for all of our contractor-focused businesses. Prior year segment information has been restated to conform to the current organizational structure, and we have provided restated historical results by quarter on our website. Yesterday, Graco reported first quarter sales of $494 million, an increase of 9% from the first quarter of last year. The effect of currency translation rates decreased sales by 2 percentage points, or approximately $7 million in the first quarter. Reported net earnings were $101 million for the quarter, or $0.58 per diluted share. After adjusting for the impact of excess tax benefits from stock option exercises, Net earnings were 99 million or 57 cents per diluted share. The gross margin rate was 60 basis points higher than the fourth quarter of last year, but is down 300 basis points from quarter over quarter. The decline from the first quarter of last year was primarily from higher input costs and the adverse impacts of changes in currency translation rates. Our 2022 pricing actions are taking hold and we expect to realize the full impact of our price increases as we move through the second quarter and sell through the remaining 2021 backlog. At current costs and volumes, we expect that our 2022 pricing actions will offset these input cost pressures on a dollar basis and result in a modest gross margin rate improvement in the second half. Of course, costs of many commodities remain volatile and will be closely monitored. Total operating expenses increased $7 million in the quarter, which includes a $3 million charge for the full exposure of our receivables in Russia and Belarus. This amount is included in unallocated corporate expense. We have currently suspended our sales in Russia and Belarus. While we do not have any physical operations in the country, we do have a handful of employees. Sales to Russia and Belarus in 2021 were approximately 1.5% of total consolidated sales. Interest expense increased by $3 million in the quarter. This increase relates to a $3.5 million fee associated with the prepayment of $75 million of our private placement debt. The adjusted effective tax rate was 19% for the quarter, which is comparable to the first quarter of last year. Cash flows from operations totaled $31 million, a decrease of $70 million from last year, mostly driven by an increase in annual incentive payments and inventory purchases to meet demand levels. During the first quarter, we repurchased 1.5 million shares for $109 million, which will largely offset our dilution in 2022. As I mentioned earlier, we prepaid $75 million of our private placement debt We also made capital expenditures of $47 million and had dividend payments of $36 million. Finally, our foliar estimates for currency impacts on allocated corporate expense, tax rate, and capital expenditures can be found in the conference call slide deck on page 11. 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. We started the year strong with record quarterly sales in all reportable segments. The industrial and process segments experienced broad-based sales growth in all regions. In contractor, North America and Asia Pacific remained positive, but EMEA saw a decline in the quarter driven primarily by limited product availability due to component shortages for large paint sprayers. Incoming order volume remains elevated and outpaces our ability to deliver. Long lead times in key materials and components such as electronics, castings, engines, and motors resulted in a 19% increase in our backlog from the end of last year. Our consolidated backlog was approximately $445 million at the end of the first quarter, which is $70 million higher than what it was at the end of last year. We have implemented our annual price increase. However, as expected, due to the size of our year-end backlog, which is at last year's pricing, we did not realize its full impact during the quarter. A majority of last year's backlog has now been shipped. Therefore, we should see a greater impact from pricing on profitability for the remainder of the year. At current costs, we believe that our pricing actions will be enough to offset cost pressures from inflation on a dollar basis. Now turning to some commentary on our segments. After a very strong first quarter last year, the contractor segment was up low single digits in the quarter. We were heavily impacted by component shortages for our large paint sprayers, which primarily serves our North America and EMEA customers. Our inability to ship these larger, more profitable units negatively impacted operating earnings during the quarter. Our incoming order rates have continued to grow in all product lines, resulting in a backlog of over $100 million, which is up 20% since the end of last year. While mortgage interest rates have increased recently, contractors remain busy. Housing starts are still protected to be 1.7 million units this year. New and existing home sales remain strong. Commercial construction is forecasted to be up mid-single digits, and remodeling is forecasted to increase double digits during the year. We believe that our 2022 pricing actions, largely implemented in the quarter, along with improved product mix, should positively impact profitability and contractor for the remainder of the year. The industrial segment posted its fifth consecutive quarter of double-digit growth. The segment grew mid-teens and achieved first quarter records for sales and operating earnings resulting in impressive incremental margins of 64%. Sales remain strong in all major geographies, with solid demand in many product categories, such as liquid finishing, powder coating, and sealant and adhesive equipment. We are still facing component and logistical constraints, which have contributed to an increase in backlog of $24 million compared to the end of last year, and $75 million compared to the same time last year. The process segment grew 26% for the quarter, resulting in records for both revenue and operating earnings. We saw continued strength in demand for worldwide lubrication equipment, process pumps, and semiconductor products. Incremental margins were negatively impacted by cost pressures on key components. Backlog is elevated, and we're optimistic that the pace of business will persist throughout 2022. Moving on to our outlook. Underlying demand in our key end markets and geographies remains healthy. However, we are keeping a close eye on how economic and geopolitical conditions may impact the balance of the year. For now, we are confirming our 2022 revenue guidance of high single digits on an organic constant currency basis. with growth expected in every reportable segment. While operational challenges persist, we intend to fully execute against our core strategies. We are investing in new product development initiatives. We continue to make investments in our facilities and distribution channel. We are focused on finding profitable growth opportunities in attractive niche markets through a combination of both organic initiatives and a new focus on external activities, including acquisitions. I'm proud of the hard work that our teams are doing in some challenging times. It's fantastic to see everyone stepping up to help in classic Graco fashion. That concludes our prepared remarks. Michelle, we're ready for questions.