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 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 2022 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.grayco.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, everyone, and thank you for joining our call. I'm here today with Mark Sheehan and David Lowe. I will provide a brief overview of our quarterly results before turning the caller to Mark for additional discussion. Yesterday, Graco reported first quarter sales of $530 million, an increase of 7% from the first quarter of last year. The effect of currency translation decreased sales by three percentage points, or approximately $11 million. Reported net earnings increased 28% to $129 million for the first quarter. Diluted earnings per share were 75 cents, an increase of 29% over last year. The gross margin rate increased 230 basis points in the quarter. This improvement was primarily the result of the pricing actions we have taken over the past 15 months, as well as improved product and channel mix, which is mainly coming from our contractor segment. Input costs remain elevated. However, our pricing actions have taken hold, and we are seeing improvements in our gross margin rate as a result. At similar costs and volumes, we expect that the gross margin rate improvement we experienced in the first quarter will continue throughout the remainder of the year. Total operating expenses increased $2 million in the quarter. Operating expense leverage along with top line growth and gross margin rate improvement led to operating earnings growth of 22%. Interest expense decreased by $4 million in the quarter. This decrease relates to the prepayment of $75 million of our private placement debt that occurred in the first quarter of last year. The adjusted effective tax rate was 19.5%, which is comparable to the first quarter of last year. Cash provided by operations totaled $91 million, an increase of $60 million from last year, primarily driven by net earnings improvement and a reduction in inventory purchases. We also made dividend payments of $39 million and capital expenditures of $38 million. A few comments as we look forward to the rest of the year. Based on current exchange rates, we expect the effect of currency translation would have no impact on net sales or net earnings in 2023. The unfavorable effects of currency expected in the first half will be offset by favorable impacts in the second half. We now expect unallocated corporate expense to be approximately $34 to $37 million. This updated range reflects higher stock compensation as a result of changes in market-based valuation assumptions. Our full year tax rate is expected to be approximately 19 to 20% on an as-adjusted basis. And finally, capital expenditures are estimated to be $200 million, with $130 million related to facility expansion projects. I'll turn the call over to Mark now for further segment and regional discussion.

Thank you, Kathy. Good morning, everyone. All of my comments this morning will be on an organic constant currency basis. Sales were up 10% for the quarter and we achieved record first quarter revenue and operating earnings. We saw revenue growth in all segments and regions with the exception of Asia Pacific, which had soft demand at the beginning of the year in both the industrial and contractor segments. In Asia Pacific, many of our key end markets remain strong, such as e-mobility, battery, alternative energy, and electronics. However, these are more than offset by softening sales in construction and powder finishing. As the quarter progressed, incoming order rates rebounded, and we anticipate growth in the region on a full year basis. Pricing actions implemented last year drove sales growth and gross margin expansion during the first quarter. Our strong price realization across all businesses and regions, along with favorable product mix in contractor, resulted in a meaningful improvement in our gross margin rate, which has risen to normal Graco levels that were last seen in the first quarter of 2021. These improvements, along with good expense management, resulted in company-wide incremental margins of 80%, Operating earnings expressed as a percentage of sales were 30% for the quarter, which is the highest in company history despite continued foreign currency pressures. Our pricing strategy over the past couple of years has been to cover rising input costs and to restore the gross margin rate to pre-inflationary levels. With similar volumes for the rest of the year, we should see continued strong margin performance. Our consolidated backlog was $350 million at the end of the quarter, which is consistent with where it was when we ended last year. While supply chains are improving, we still have shortages in key components such as electronics and castings, which have prevented our backlog from returning to more normalized levels. Now turning to some commentary on our segments. The contractor segment had mid single digit revenue growth, resulting in first quarter records for both revenue and operating earnings. Our pro paint and high performance coatings and foam businesses remain strong, but we're partially offset by ongoing softer conditions in the home center channel. This change in demand at the home centers was not unexpected given the large ramp in business we've experienced since 2020. Growth in EMEA during the quarter was a bright spot as product availability improved and they had strong price realization. Asia Pacific, on the other hand, declined 8% as the shipping container business and construction markets have weakened. As expected, new single-family housing starts in North America have slowed during the quarter, but improving commercial and multifamily residential were more than enough to offset the decline. Professional painting contractors remain busy with order books extending throughout much of 2023 and even into 2024 for commercial applications. Operating earnings were 30% during the quarter as CED benefited from selling larger propane sprayers and fewer home center units. Pricing actions also contributed favorably in the quarter versus what we experienced last year. Incremental margins in contractor were more than 100% in the first quarter. The industrial segment grew 7%, resulting in record first quarter revenue and operating earnings. Our liquid finishing and sealant and adhesive businesses led the way, but were partially offset by lower systems sales in our powder finishing business, especially in Asia Pacific. Backlog in powder equipment systems remains elevated overall, which should offset the softer start to the year. Additionally, we expect to benefit from new product releases in the back half of this year. The process segment grew 16%, resulting in first quarter records for both revenue and operating earnings. This is the ninth consecutive quarter that process has set these records. Continued broad-based sales growth in vehicle service, industrial lubrication, process transfer pumps, Environmental and semiconductor drove the strong performance. Pricing actions taken along with careful expense management drove 75% incremental margins for the quarter and resulted in 30% operating margins, which is a record for the segment. Momentum continues to build as project activity and lubrication, environmental, and process pumps are robust. Backlogs remain elevated, particularly in semiconductor. And there is excitement around our recent upcoming new product releases. Moving on to our outlook. We are encouraged by the start of the year. End market activity and demand for our new and existing products remain solid. However, given the volume comparisons in the second half will be more challenging as we lap some of the price increases we took last year, we'll continue to watch incoming order trends and business tempo as we remain optimistic for growth in both sales and operating earnings for the full year. Therefore, we are confirming our outlook of low single-digit organic revenue growth on a constant currency basis. That concludes our prepared remarks. Operator, we're ready for questions.