Graco : 4th QUARTER 2020 EARNINGS CONFERENCE CALL (Transcript)

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Q4 2020 Graco Inc Earnings Call

EVENT DATE/TIME: JANUARY 26, 2021 / 4:00PM GMT

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JANUARY 26, 2021 / 4:00PM GMT, Q4 2020 Graco Inc Earnings Call

CORPORATE PARTICIPANTS

Kathryn L. Schoenrock Graco Inc. - Executive VP, Corporate Controller & Principal Accounting Officer

Mark W. Sheahan Graco Inc. - CFO & Treasurer

Patrick J. McHale Graco Inc. - President, CEO & Director

CONFERENCE CALL PARTICIPANTS

Andrew Edouard Buscaglia Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

Bryan Francis Blair Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

Deane Michael Dray RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment & Analyst Jeffrey David Hammond KeyBanc Capital Markets Inc., Research Division - MD & Equity Research Analyst

Joseph Alfred Ritchie Goldman Sachs Group, Inc., Research Division - VP & Lead Multi-Industry Analyst Matt J. Summerville D.A. Davidson & Co., Research Division - MD & Senior Analyst

Michael Patrick Halloran Robert W. Baird & Co. Incorporated, Research Division - Associate Director of Research & Senior Research Analyst

Saree Emily Boroditsky Jefferies LLC, Research Division - Equity Analyst

Walter Scott Liptak Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

PRESENTATION

Operator

Good morning, and welcome to the fourth quarter conference call for Graco Inc. (Operator Instructions)

If you wish to access the replay for this call, you may do so by dialing (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 5162659. The replay will be available at through 2:00 p.m. Eastern Time, Tuesday, February 2, 2021.

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 the 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 indicated as a result of various risk factors, including those identified in Item 1A of the company's 2019 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. Looking-forward 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 the new information or future events.

I will now turn the conference over to Kathy Schoenrock, Executive President, Corporate Controller.

Kathryn L. Schoenrock Graco Inc. - Executive VP, Corporate Controller & Principal Accounting Officer

Good morning. I'm here today with Pat McHale and Mark Sheahan. Our conference call slides have been posted on our website and provide additional information that may be helpful.

Sales totaled $470 million this quarter, an increase of 14% from the fourth quarter last year and an increase of 12% at consistent translation rates. Net earnings totaled $115 million for the quarter or $0.66 per diluted share. After adjusting for the impact of excess tax benefits from stock option exercises, net earnings totaled $106 million or $0.61 per diluted share. Gross margin rates increased 130 basis points from last year's fourth quarter. Realized pricing and foreign currency were favorable in the quarter. Mix was also favorable as we saw the margin impact of sales growth in our higher-margin Industrial segment more than offset the continued strength in our lower-margin Contractor segment.

Operating expenses increased $7 million in the fourth quarter as compared to a year ago due to increases in sales and earnings-based expenses and higher product development costs.

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JANUARY 26, 2021 / 4:00PM GMT, Q4 2020 Graco Inc Earnings Call

The reported income tax rate was 11% for the quarter, down 5 percentage points from last year, primarily due to an increase in tax benefits related to stock option exercises. After adjusting for the effect of stock option exercises, our tax rate for the quarter was 18%, slightly lower than the fourth quarter last year due to additional foreign income taxed at lower rates.

Cash flows from operations totaled $131 million in the fourth quarter and $394 million for the full year. Discretionary cash outflows in the quarter included the final repayment of $125 million of the $250 million borrowed on the revolving credit facility in the first quarter. We also made a voluntary contribution of $20 million to our U.S. pension plan. For the full year 2020, dividends paid totaled $117 million, and capital expenditures were $71 million.

A few comments as we look forward to 2021. Based on current exchange rates and the same volume and mix of products and sales by currency, the effect of exchange is currently expected to benefit sales by 2% and earnings by 6% for the full year, with the most significant impact coming in the first half. Unallocated corporate expenses are projected to be $30 million and can vary by quarter. The effective tax rate for the year is expected to be 18% to 19%. Capital expenditures are expected to be $115 million, including $80 million for facility expansion projects. We may make share repurchases in 2021 via opportunistic open-market transactions or short-dated accelerated share repurchase programs.

Finally, 2021 will be a 53-week year with the extra week occurring in the fourth quarter.

I'll turn the call over to Pat now for further comments.

Patrick J. McHale Graco Inc. - President, CEO & Director

Thank you, Kathy. Good morning everyone. All of my comments this morning will be on an organic constant currency basis. The second quarter in a row the Contractor segment exceeded 30% growth and ended the year with record sales and earnings. Contractor grew in all regions during the quarter and for the year. Residential construction activity remains solid, and the home improvement market robust.

Contractor North America saw strong out-the-door sales in both pro paint and home center, and we continue to work hard to maintain adequate channel inventory.

The Industrial segment grew mid-single digits for the quarter but still ended the year, down 10%. Compared to the previous 3 quarters, activity improved in some key end markets like spray foam, electronics and battery. Access to industrial facilities remains limited, but quoting activity has improved. The Asia Pacific region was up versus last year's Q4, which was particularly weak. Price realization, solid factory performance and good expense management, combined with improved sales, resulted in strong Industrial operating earnings for the quarter.

Process segment sales declined 10% for both the quarter and the year. A number of markets in our Process segment remain challenged, particularly those related to the vehicle lubrication or oil and gas sectors. Heading into 2021, we expect challenging end market conditions to remain in place in our Industrial and Process segments for at least the first half of the year as lockdowns persist and access to customers remains limited. Our outlook for the Contractor segment remains positive as favorable conditions continue, and demand has been solid to start the year.

Thanks to our outstanding employees, suppliers and distributor partners, we were able to keep our factories and distribution centers fully operational, avoid layoffs and wage reductions and fully invest in our core long-term growth strategies of new product development, channel expansion and new markets. A special thanks is in order to our Contractor employees and the employees from other factories who relocated to the Contractor factory to assist with a large demand spike in the second half. From the sales team to the shop floor, the Contractor team worked incredibly long hours, maintained a positive attitude and were committed to doing whatever it took to get the job done. Culture matters, and they are winners. We exited the year with momentum and look forward to the fight again this year. Operator, we're ready for questions.

QUESTIONS AND ANSWERS

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JANUARY 26, 2021 / 4:00PM GMT, Q4 2020 Graco Inc Earnings Call

Operator

(Operator Instructions) Our first question will come from the line of Deane Dray from RBC Capital Markets.

Deane Michael Dray RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment & Analyst

Can we start in Contractor? Just a couple of things. One is, what's the visibility beyond the 6-week average orders that you're giving, which we appreciate. But just what are kind of the data points that you're using, you expect to stay robust? If you have line of sight into that? And then also, you called out some mix issues in the segment. Maybe you can clarify that, too, please.

Patrick J. McHale Graco Inc. - President, CEO & Director

So it's a book-and-bill business. So we're always interested every week in what's happening with incoming order rates. However, when you take a look at the macro, residential construction, looks like it's going to remain in pretty good shape through 2021. So we expect to capitalize on that. And at least currently, what we're hearing and what we're seeing, there doesn't appear to be a big pullback in what's happening with the home centers work-from-home business. So we feel like, based upon the orders to start the year and what we're hearing in the marketplace that we've got a good shot of having a successful year in Contractor, despite the fact that we do have some very tough comps that we're going to be up against as we get into the peak that we hit this year.

In terms of the mix issue on Contractor, typically, that's just a mix issue between selling more of the smaller units than the larger units or home center business versus pro paint.

Deane Michael Dray RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment & Analyst

All right. That's helpful. And then just as a follow-up, can you clarify for us on what the opportunity is in batteries? I mean when we talk to our auto analyst, he keeps emphasizing all the growth in batteries and capacity that's coming on new technologies, and just remind us where and how does Graco play in that market?

Mark W. Sheahan Graco Inc. - CFO & Treasurer

Yes. Deane, it's Mark. And we play in our Industrial segment in areas where customers are putting in new battery facilities, and they're looking to use fluid compounds to either do bonding of various components of the batteries themselves, or we also get involved in what's called thermal interface materials, which are highly reactive abrasive materials that are put down to dissipate heat when batteries are actually being used. And we have the equipment and the expertise to get involved in those applications, along with our distributor partners to put together nice packages for the end users. So as long as there's demand for batteries, we expect that we're going to get a fair shot at being able to be involved in those opportunities.

Deane Michael Dray RBC Capital Markets, Research Division - MD of Multi-Industry & Electrical Equipment & Analyst

Got it. And if I could just squeeze one more question in? Can you talk about pricing expectations? I know it's at the beginning of the year is when you put through pricing. What are the dynamics this year? And anything contribution from new products you expect to launch?

Patrick J. McHale Graco Inc. - President, CEO & Director

Yes. Pricing ought to be like it is typically. We generally put through a modest price increase each year and expect to realize somewhere in that 1.5%, maybe up to 2% realized pricing. I don't think this year is going to be really anything different on that. We did not cut any of our new product investments or our new product programs. So we feel like our new product pipeline for '21 and even going into '22 looks pretty good.

Operator

Our next question will come from the line of Saree Boroditsky from Jefferies.

Saree Emily Boroditsky Jefferies LLC, Research Division - Equity Analyst

We're hearing that there's a lot of capital being spent on automation in China right now. Could you comment on what you're seeing there that drove the pickup in Industrial? And then do you think that COVID will increase the demand for more automation in factories globally?

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