Graco Inc (GGG) 2017 Q1 法說會逐字稿

Good morning, and welcome to the First Quarter 2017 Conference Call for Graco Inc.

If you wish to access the replay for this call, you may do so by dialing 1 (888) 203-1112 within the United States or Canada. The dial-in number for international callers is (719) 457-0820. The conference ID is 7118428. The replay for -- will be available through May 1, 2017.

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 question-and-answers after the opening remarks from management.

During this call, various remarks will be made by management about their expectations, plans and prospects for the future. These remarks constitute forward-looking statements for purposes of the safe harbor provisions from the Private Securities Litigation Reform Act. Actual results may differ materially for those indicated as a result of various risk factors including -- identified in Item 1A of the company's 2016 annual report 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, www.graco.com; the SEC's website at www.sec.gov. Forward-looking statements reflect management's current view and speak only of the time they are made. The company undertakes no obligation to update these statements in light of the new information or future events.

Today's call is recorded.

I will now turn the conference over to Caroline Chambers, Vice President, Corporate Controller and Information Systems. You may now go ahead.

Good morning, everyone. I'm here this morning with Pat McHale and Christian Rothe. Our conference call slides are on our website and provide additional information on our quarter.

Graco sales for the first quarter of 2017 totaled $341 million, an increase of 12% from the first quarter last year. And net earnings totaled $61 million, an increase of 54%. Diluted earnings per share were $1.05, which included $0.05 from a required change in accounting for stock compensation and $0.01 from reduced intangible amortization expense relating from the impairment charge recorded in the fourth quarter of 2016. Foreign exchange was a slight headwind in the quarter, and the effect of foreign translation rates reduced sales by approximately $4 million and net earnings by approximately $1 million.

As a result of strong factory performance and realized pricing, our gross profit margin rate increased by more than 1 percentage point from this quarter last year. We are not yet seeing the effect of rising commodity prices, though if commodities remain elevated as compared to last year, we will begin to see some effects in the second half of the year. We have a variety of cost-reduction activities underway, as we always do. And we believe that these cost reductions will largely offset the effect of rising commodity prices this year.

Operating expenses were slightly lower than last year due to the effect of currency translation, lower amortization expense and lower stock compensation and warehouse expense. A reconciliation of our operating earnings is included on Page 7 of our slide deck.

The effective tax rate for the quarter was 26%. I mentioned earlier the $0.05 effect on EPS related to the adoption of the new accounting standard related to stock compensation. With the adoption of the new accounting standards, $3.7 million of excess tax benefits related to stock option exercises that would have been credited to equity under the old standards have now been credited to the tax provision, reducing the effective tax rate by 4 percentage points. Without that accounting change, the effective tax rate was 30%. Since this benefit is recorded when stock options are exercised, the effect will vary from quarter to quarter. Excluding any effect from the change in accounting for stock compensation, the effective tax rate for the second quarter and the full year is expected to be approximately 30%.

Net cash from operations totaled $50 million, up from $29 million last year. 850,000 shares of stock were repurchased in February through an accelerated share repurchase plan. And 550,000 shares were issued, resulting in a net cash outlay of $60 million. We may or may not decide to make further share repurchases, and we'll evaluate a variety of factors before making that decision.

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

Thank you, Caroline. Good morning, everyone.

All of my comments this morning are on an organic constant currency basis.

It was a solid first quarter with growth in every segment and every region of the world and good performance in both developed and emerging economies. We're pleased with the strong start to the year; and thank our suppliers, distributor partners, employees and loyal customers for their help in getting out of the gate well. Because demand was broad based geographically and across product categories and we go into a fair bit of detail in our slide deck, I'll focus my comments on a few of the areas where we're seeing headwinds moderate.

Our Oil and Natural Gas operations were slightly better than flat year-over-year, so we're hoping that we are seeing the bottom. Most of our exposure in the space is on the production side, so there may be some lag from what others are seeing on the exploration side. Mining provided some growth for our Process segment in the first quarter, which is a positive sign. Demand in this space can be lumpy quarter to quarter, but with higher commodity prices, conditions for us should be generally improving. Through discussions with distributors and end users, it's clear that confidence levels domestically are better today than a year ago. Our view is that it's still a bit early to declare that the U.S. industrial economy has fully turned the corner, but we are encouraged by the direction of the business.

A few points regarding Graco overall order rates. Incoming order rates were strong every month of the quarter in every region, and all segments were in positive territory every month of the quarter. Over the past 3 years, we've called out week-to-week volatility in order rates. In the first quarter, we saw that volatility soften, which is indicative to us that the worldwide economy may have found some footing. But it's only 1 quarter, and we'd like to see more of that week-to-week predictability as we go through Q2 and into the summer. Orders through the first 3 weeks of April continued to be solid. Mindful of a tough Q4 comp, we'd like to see good top line performance continue through Q2.

One comment specific to our Contractor segment. Contractor is off to a strong start this year. You'll recall that we were down slightly in Q1 of last year, as new product launches pushed out into Q2, so we have an easier comp in Q1 but we'll have a much more difficult comp in Q2. Notably, the 2017 product launches have been well received, and we expect these products to contribute nicely to 2017 full year results.

Moving on to profitability. Incremental margins were outstanding in the first quarter, with the Industrial and Process segments well over 50% and Contractor solidly into the 40s. As we've discussed before, the Graco business model levers nicely at higher growth rates. Over the cycle, we expect incremental margins in the high 30s to the low 40s.

Moving on to our outlook. Based on the solid performance in the first quarter, we're raising our full year 2017 outlook from low single digits to mid-single digits. As always, we continue to press forward with our long-term growth initiatives and hope that our outlook for 2017 may indeed be too conservative.

Operator, with that, we're ready for questions. Chris, are you there?

(Operator Instructions) And we will take Mike Halloran of Robert Baird.

So just a couple questions here on sustainability, Pat. Some good color there about trends through the quarter, lessening volatility. In your view, do you think there's anything in the revenue line in the first quarter that -- assuming things stay about on the footing they are at today, that wouldn't imply normal sequentials as you look forward in any of the segments?

No. Business conditions seem to be pretty good and pretty healthy across most of our end markets and across most of our geographies. Didn't see anything really strange in the first quarter. It's nice to see some strength across-the-board. We haven't really seen that consistently for the last, I don't know, couple years, anyway. And so I've got some optimism going into Q2, but it's early. And we'd like to see that continue before I ring any bells.

No. Absolutely that makes a lot of sense. And then the same question on the profitability side, as -- 35 to low-40s kind of incrementals. Maybe some thoughts on in particular the Process segment where the incrementals were obviously a lot higher in the first quarter relative to that number, coming off a more depressed base. Is the first quarter the right base to think about on the Process side on a forward basis relative to revenue levels we're at right now?

So whether you're talking about the Process segment or Graco overall, we've talked many times before, is that we lever good on volume. And when our volume is low, it's hard to drive profitability. We don't do big restructuring activities every time we have a bad quarter. We kind of stick to our knitting and invest in our growth initiatives. And when we get a good revenue performance, we flow a lot through to the bottom line. So we believe that over the long term that high 30s to low 40s is the right kind of flow-through to think about. In quarters where we exceed on the top line, you're more likely to see higher flow-through. And on quarters where we're weak, you'll see less. And I think that model hasn't changed.

Last quarter, you talked about some -- last couple quarters, you talked about some just factory-oriented constraints in the Contractor side that might compress that incremental margin a little bit just because you're running from -- so high relative to what's been really good volumes there. Is that still the case? Or is -- are you able to free up a little room?

No. We've done some things to give ourselves a little bit of breathing room up there. We have enough capacity to produce the demand this year. It's always a challenge in manufacturing to make sure you have parts and all the other things that can go wrong, but from a stays -- space standpoint, we've added a little bit of storage space and moved some things out. So I'm not concerned about it.

Up next, from Oppenheimer, we'll go to Jim Giannakouros.

Very nice quarter, specifically on the costs side, cost management, so I guess my question there is, is there anything -- or how should we be thinking about the SG&A progression the rest of this year relative to 1Q?

Jim, it's Christian. So with regard to the progression on expenses, we've got a pretty decent baseline that's already been set forward. As Pat said, we don't -- have necessarily not achieved but we are going to have the amortization that's obviously going to be lower in Q2, Q3. And in addition to that, of course, whatever assumptions you make on the volume side will, of course, make changes around SG&A.

Got it, okay. And at the plant level, in the past, you've spoken about your internal goal to achieve 0 cost manufacturing increase each year. Is that in your current plan? And if you can talk about the puts and takes there, that would be helpful.

Yes. This is Pat. Generally, as far as I can remember, that's in our plan every year. And so we always have the usual pressures with some wage increases and medical cost increases. Some years, commodities help us. Some years, they hurt us. This year, we're expecting that they'll be a headwind for us but that volumes should help the factories certainly on overhead absorption. And volume also helps us drive additional cost-reduction activities. I would anticipate that, as we go through this year, we're going to see more factory requests for machines that'll improve quality and drive out costs, particularly in the second half of the year. I would anticipate some increased CapEx and some costs associated with that, but those are the kind of things that help us achieve 0 cost change. And with volume, I think we've got a real good chance of hitting that.

Got it. And one more, if I may, when thinking about, I guess, the margin potential in each segments, starting with Industrial's. Factoring Gema's, I think it's, 300 to 400 basis points kind of weight on Industrial's margins, it seems that you're at or above prior peak now. If you can comment if there's a potential expansion potential there. And I guess, same question for Contractor, appreciating that mix has kept the segment potential below prior peak, if I recall.

All right, Jim. This is Christian again. So with regard to Industrial, the way to get margin expansion on the operating margin line, we can still do it but we do definitely need to have a higher growth rate. And it's going to be basis points, as opposed to percentage points. On the Contractor business we still feel like, that business, as we get higher volumes, we can get to the mid-20s on operating margins. I'm not sure how much runway there is beyond that. On the Process segment, again that's volume dependent, but we believe that we can get -- be back in the 20s. That's -- those are all over the medium to long term.

And our next question comes from Deane Dray of RBC Capital Markets.

This is Jeff Reive on for Deane Dray. My question is about your revised 2017 outlook. I noticed you're incrementally more positive on Process in all regions than Industrial America. I wonder if you can just kind of talk about what you're seeing there and kind of the tone and if America is pretty broad based is what you're seeing.

This is Christian. So the incrementally positive, obviously it's based on what we're seeing on the incoming orders. We're seeing that shipment levels go up. It's been -- you could see a pretty decent, broad-based growth on especially the Process segment. So that's really -- and I think you're talking about our Current Environment and Outlook slide in our slide deck. That's Slide 11. So we did feel like going from reds across-the-board, on Process, to something that have more yellows, and it's growth rate to us. And as Pat said, Oil and Natural Gas was just above flat for the first quarter. We'd like to see some more improvement in that area before we feel like we're [really starting getting something like] better. The remainder of the business that is Process, though, did have a solid performance in the first quarter. Around the Americas Industrial business, again I think (inaudible) made some comments about the fact that it does seem like there's better confidence [a little] out there, which is great, but again we're looking to see more as we go through Q2 and into summer.

Okay, great. And to follow up, Industrial, you also noted some of the improvement was due to some promotion timing. Can you just talk about what those were and if there's any pull-in from 2Q?

Promotion activity happens for us all the time, so it's not an unusual thing. It's not really a pull-in either. We're talking about changes that are not dramatic.

And we'll take our next question from Matt Summerville with Alembic Global Advisors.

Several questions. First, can you quantify? I believe it was an $8 million impact you had, I think, in the second quarter of '16 associated with your new product loading in Contractor. Can you provide a similar quantification for what you thought that was in Q1 of '17 and then maybe just some color around the types of new products you've been launching in that space?

Yes. We didn't have a launch in Q1 of '17 that was anywhere similar to what you saw in Q2, so I'd say basically not an impact for us in Q1. New products that have been well received that are launching up in particular in the Contractor division include a new generation of handheld paint sprayers. We're pretty excited about that. We launched the original version a number of years ago. And we've upgraded the performance and capabilities on that a couple 3 times here, so we've got an all-new one that we've launched this year, to good reaction. We also have a low-pressure tip which really provides some nice benefits to contractors to be able to atomize paint at low pressures. It gives them less over-spray. And the ability to run their comps at a lower pressure also should give them more life. So we've got some other products as well. I don't want to stick here and spend all my time talking about new products, but generally the slate of new products on CED have been well received and should help us throughout the year.

Did you get the sense that the level of spend you're seeing in Industrial -- and I think you mentioned in your press release you maybe had some promotional activities in the Americas, but just are you starting to see customers adding incremental productive capacity? Or are you seeing more recapitalization of existing production lines?

So what I'm hearing is more optimism. I'm not sure that we're seeing a big turn in investment yet, but really looking at the results of the other industrial companies that have been reporting, I've got to say I'm feeling pretty optimistic. It looks like most people are seeing an inflection point here and better domestic industrial activity. We're seeing that as well. Again, I hate to get too excited over 1 quarter, but I think the direction looks good. And let's see what happens going forward.

And then just last thing, maybe just to clarify. If you look at kind of the normal, if you will, earnings seasonality for Graco, typically Q1 is a low point. Is there any reason to believe based on what you've seen year-to-date, through the first 3 weeks in April that Q1 is not the low point of the year? Or do we need to bear in mind that comp in Q2 you faced in Contractor and the fact that you had 1 extra week last year versus this fiscal year?

No. I remain relatively optimistic at this point that the normal cycle should prevail.

Our next question comes from Saree Boroditsky.

You've had some really strong growth in APAC Industrial in the quarter, so just talk about what you were seeing in that market and how you're thinking about growth going forward.

Saree, this is Christian. So with regard to Industrial Asia Pac, this really is a continuation of what we've seen over the last two years, which is pretty good project activity coming through. And I think our team needs to feel like that, that market is finding footing and that we're going to be able to build the base off of this. So that was positive. Now we've always cautioned folks that, if it -- if we have a lot of growth driven by project activity, it's going to be spotty through quarter to quarter. We've had a good string here, but we're just cautious with that variability.

Okay, I appreciate that. And then I -- just going back to the oil and gas markets. You had slight growth in the quarter. So maybe if you could provide any additional color on what you're seeing in that market and how to think about that for the rest of the year.

Generally our exposure on direct oil and gas isn't very big, so I would say, if you're looking for color on oil and gas market, there's a lot better people to talk to than us. We see a very, very small slice of it. And looking at our shipments and incoming order rates, I guess we more or less called bottom here in the first quarter, at least for us. And we hope that, that turns out to be the case.

(Operator Instructions) And we'll go next to [James Picareo].

Just a sort of quick question on price cost. I mean you guys mentioned a material inflation likely emerging in the second half a bit but should be offset by cost-out actions. Can you just talk about or maybe quantify what -- how you're thinking about that material inflation in the back half?

Yes. Again, the Graco model, we have some advantages right out of the gate in terms of the percentage of a revenue dollar that's really related to raw materials. With the gross margin that we have and the high value-add that we have in our factories, we're not as whipsawed by commodity price changes, as some other folks might be. We generally have good cost-reduction programs going on by our factory folks. And what we're seeing in commodity prices, to us, looks like something that we're going to be able to handle through the year. Certainly, if you -- and that's really talking about factory performance with the volume and the cost-reduction projects. If you take a look at price cost, we do an annual price increase. We run that at the beginning of the year. We did it again this year. So I feel like we're going to be in just fine shape.

Understood. And then just on capital allocation. Deals obviously remain elusive. Just wondering what you see in the pipeline there, if anything. And then on buybacks, you committed a net $60 million in the first quarter. How you are thinking about that going forward?

Well, I'll talk a bit about deals. And then Chris, you can talk about the buybacks, but on the deals side, there is activity out there. We do have an active process inside the company. Multiples remain high, so whether we're going to bring any home or whether we're not, I guess time will tell, but there are things that are out there for us to look at. And we do have some niche markets that we're interested in. So we're going to run our normal drill on that. Chris, do you want to talk about...

Sure. On the buybacks, it was mentioned already. We did do a small ASR in the first quarter. That's still in process and hasn't concluded yet, but it's -- probably it is not going to offset the creep for this year. We will continue to evaluate whether or not we want to jump back in and buy more of the remainder this year. It's depending on a number of factors, including internal modeling and what's going on in the broader marketplace. So haven't ruled it out, but we are continuing to look at all the factors.

We'll go next to Charley Brady.

Gosh, I think it's the only one I really have, is I'd touch back on the prior question on mix within Contractor. And you've talked about high, low -- low, medium, high kind of margin/mix. And previously that -- given the recovery, that really hadn't -- the mix of the high end, higher margin, that's still kind of been a little bit below where it was maybe in past cycle or past cycle peak. Any granularity on kind of has that moved around a little bit at all?

So Q1, we had good performance by both the paint channel and the home center channel, pretty even performance between the two. We do continue to see volumes going up on higher dollar equipment, but frankly, we continue to do very well on the low end of the pro side as well. So I'd say, if you look at the mix compared to back in 2006, we're still skewed towards the bottom on the pro end, but both parts of the product line are growing.

That's helpful. And just one more, I guess, just in Contractor. You've got obviously one pretty big competitor out there. Is -- are you seeing any irrational behavior from them? Or is it a pretty rational market?

I think the environment across our competitive lines is stable. We've got good competitors across all of our product categories. And we're out there beating each over -- beating each other over the head every day with a log, and I don't really see anything different.

And we'll go next to Walter Liptak.

I wanted to ask about the mid-single-digit revenue guidance. And with the way that the first quarter came through, I wonder why you didn't go to a high single-digit number. I -- and I understand the comps that you're going to be going up against in Contractor, but everything seems positive. You might get some more cyclical recovery this year. What was the thought behind the mid-single digit?

I hope you're right. It's been a slog the last couple of years, as you know. We've done okay, but every day it's been carrying a big bucket of rocks up the hill. So 1 quarter that we have is really good and incoming order rates still holding up, but maybe it's just our natural conservatism but we're -- just we're going to take it a step at a time here.

Okay, that's great. Is there any visibility you can share with us on orders or quotes in some of the more cyclical businesses? You kind of mentioned oil and gas, but natural gas, mining, is there better activity there?

Yes, mining, we're seeing a little bit better activity. Incoming order rate in April has been solid. So in general I'm feeling pretty positive about things.

(Operator Instructions) And we'll go next to Jim Foung.

It looks like you can't show my questions, but I guess, well, [in the case we can get an answer to this]. Did you suspect any inventory building in the first quarter? Or can we just take that as just pretty much our end market demand and just great organic growth there?

Yes, I think that's mostly end market demand. Obviously, when things are on the upswing, people may put up a little bit more product on the shelf, but I don't think it was anything that was significant in Q1.

Okay. And then besides oil and gas and mining, were there any other large markets that didn't come back for you in Q1 that could help you in Q2 and the rest of the year?

One market that remained soft, it's not a large market for us but it is important, is the ag market. And I'm not anticipating that that's going to come back in Q2. I think that's probably going to continue to perform like it has here in recent quarters.

Okay, but there's potential for upside. And then any more color on M&A? I think you've talked about -- in a question there on capital allocation, but anything you closed or anything? Or would you be disappointed if you didn't do something this year?

No, I mean I try not to be too excited or too disappointed about what we get done. What I want to do is I want to see good activity by our team here in terms of identifying market niches that are interesting and doing their work. You can't predict these things, and if it becomes a disappointment, that puts us at risk of overpaying just to get something done. So we're just running our standard program. And if something happens, it happens. And if it doesn't, we will run the rest of our organic program, which is a good program as well.

There are no further questions in the phone queue at this time, so I'll turn the conference back over to Pat McHale.

All right, very good. Well, one behind us, three more to go for the year. And we're going to continue to work hard.

So we'll talk to you again late July. Thanks.

And this does conclude our conference for today. Thank you for all participating, and have a nice day. All parties may now disconnect.