Graco Inc: Form 10-Q for the period ended Sep 27, 2024

MANAGEMENT'S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

The Company supplies technology and expertise for the management of fluids and coatings in both industrial and commercial applications. It designs, manufactures and markets systems and equipment to move, measure, control, dispense and spray fluid and coating materials. Management classifies the Company’s business into three reportable segments: Contractor, Industrial and Process. Key strategies include developing and marketing new products, leveraging products and technologies into additional, growing end-user markets, expanding distribution globally and completing strategic acquisitions that provide additional channels and technologies.

The following Management’s Discussion and Analysis reviews significant factors affecting the Company’s results of operations and financial condition. This discussion should be read in conjunction with the financial statements and the accompanying notes to the financial statements.

Consolidated Results

A summary of financial results follows (in millions except per share amounts):

(1) See below for a reconciliation of adjusted non-GAAP financial measures to GAAP.

Net sales for the third quarter decreased 4 percent from the comparable period last year. Regionally, net sales decreased in EMEA and Asia Pacific. Net sales in the Americas increased in the third quarter and were flat for the year to date. Changes in currency translation rates did not have a significant impact on worldwide net sales for the third quarter and decreased worldwide net sales by $4 million for the year to date.

Operating earnings for the third quarter decreased 11 percent from the comparable period last year due to lower sales volume and higher operating expenses.

Net earnings for the third quarter decreased 8 percent from the comparable period last year as increased interest income and lower interest expense partially offset the decrease in operating earnings. On an adjusted basis, net earnings decreased 7 percent.

Excluding the impacts of excess tax benefits from stock option exercises, contingent consideration fair value adjustments and impairment charges presents a more consistent basis for comparison of financial results. A calculation of the non-GAAP adjusted measurements of operating earnings, earnings before income taxes, income taxes, effective income tax rates, net earnings and diluted earnings per share follows (in millions except per share amounts):

16

The following table presents an overview of components of net earnings as a percentage of net sales:

Net Sales

The following table presents net sales by geographic region (in millions):

(1) North, South and Central America, including the United States

(2) Europe, Middle East and Africa

The following table presents the components of net sales change by geographic region:

Gross Profit

Gross profit margin rate improved approximately 1 percentage point for both the third quarter and year to date from the comparable periods last year due to favorable price-cost dynamics.

Operating Expenses

Total operating expenses increased $9 million (7 percent) for the third quarter and $19 million (5 percent) for the year to date, respectively, compared to last year. More than half of the increase for the quarter and year to date was from investments in new product development and other growth initiatives, including the relocation to a new distribution center. Reductions in volume and earnings-based expenses of $3 million for the quarter and $8 million for the year to date partially offset the increase in operating expenses.

Interest and Other (Income) Expense

Interest expense was $1 million lower for the third quarter and $3 million lower for the year to date compared to the same periods last year as private placement debt was repaid in the third quarter of 2023. Other income increased $4 million for the quarter and $10 million for the year to date from the comparable periods last year largely due to increased interest income.

Income Taxes

The effective income tax rate was 19 percent for the third quarter and 17 percent for the year to date. Adjusted to exclude the impacts of excess tax benefits from stock option exercises, the adjusted effective income tax rate of 19 percent for the quarter and 20 percent for the year to date was comparable to last year.

Segment Results

Certain measurements of segment operations compared to last year are summarized below:

Contractor Segment

The following table presents net sales and operating earnings as a percentage of sales for the Contractor segment

(dollars in millions):

The following table presents the components of net sales change by geographic region for the Contractor segment:

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Contractor segment net sales decreased 1 percent for both the third quarter and year to date as favorable response to new product offerings was unable to offset softness in worldwide construction markets. For the quarter, price realization was unable to offset higher expenses, which resulted in a 1 percentage point decrease in the operating margin rate. The operating margin rate for the year to date increased 1 percentage point as price realization and lower product costs combined to more than offset higher expenses.

Industrial Segment

The following table presents net sales and operating earnings as a percentage of sales for the Industrial segment

(dollars in millions):

The following table presents the components of net sales change by geographic region for the Industrial segment:

Industrial segment net sales decreased 1 percent for the third quarter as timing of finishing system sales in the Americas largely offset declines in Asia Pacific. For the year to date, net sales declined 4 percent as sales growth in the Americas was unable to offset decreases in both EMEA and Asia Pacific. The operating margin rate decreased 1 percentage point for the quarter and 2 percentage points for the year to date as price realization was unable to offset the unfavorable effects of lower volume, product and channel mix, and higher expenses.

Process Segment

The following table presents net sales and operating earnings as a percentage of sales for the Process segment

(dollars in millions):

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The following table presents the components of net sales change by geographic region for the Process segment:

Continued weakness in the Process segment's semiconductor product application drove a double-digit decrease in net sales for both the third quarter and year to date. Operating margin rates for the quarter and year to date declined, driven by lower sales volume and higher expenses.

Liquidity and Capital Resources

Net cash provided by operating activities totaled $436 million in the first nine months of 2024 compared to $491 million in the same period last year. Lower net earnings, increased inventory purchases, and the timing of estimated income tax payments in 2024 drove most of the decrease. Inventory levels increased in 2024 primarily due to the effect of new product offerings. Significant uses of cash in the first nine months of 2024 included plant and equipment additions of $93 million and dividend payments of $129 million. Net proceeds from shares issued totaled $45 million, which were partially offset by share repurchases of $31 million.

For the first nine months of 2023, significant uses of cash included plant and equipment additions of $146 million, dividend payments of $119 million, and long-term debt payments of $75 million. Net proceeds from shares issued totaled $54 million, which was partially offset by share repurchases of $27 million.

As of September 27, 2024, the Company had available liquidity of $1,539 million, including cash and cash equivalents of $764 million, of which $226 million was held outside of the U.S., and available credit under existing committed credit facilities of $775 million.

Cash balances and unused financing sources are expected to provide the Company with the flexibility to meet its liquidity needs for the next 12 months and beyond, including its capital expenditure plan, planned dividends, share repurchases, announced and potential future acquisitions, and operating requirements. Capital expenditures for 2024 are expected to be approximately $120 million, including $70 million in facility expansion projects. The Company may make opportunistic share repurchases going forward.

Outlook

The Company's end markets and regions continue to face demand challenges. The Company reaffirms its full-year 2024 revenue guidance of a low single-digit decline on an organic, constant currency basis.

Cautionary Statement Regarding Forward-Looking Statements

The Company desires to take advantage of the “safe harbor” provisions regarding forward-looking statements of the Private Securities Litigation Reform Act of 1995 and is filing this Cautionary Statement in order to do so. From time to time various forms filed by our Company with the Securities and Exchange Commission, including our Form 10-K, Form 10-Qs and Form 8-Ks, and other disclosures, including our 2023 Overview report, press releases, earnings releases, analyst briefings, conference calls and other written documents or oral statements released by our Company, may contain forward-looking statements. Forward-looking statements generally use words such as “expect,” “foresee,” “anticipate,” “believe,” “project,” “should,” “estimate,” “will,” and similar expressions, and reflect our Company’s expectations concerning the future. All forecasts and projections are forward-looking statements. Forward-looking statements are based upon currently available information, but various risks and uncertainties may cause our Company’s actual results to differ materially from those expressed in these statements. The Company undertakes no obligation to update these statements in light of new information or future events.

Future results could differ materially from those expressed, due to the impact of changes in various factors. These risk factors include, but are not limited to, risks relating to the demand for our products and the level of commercial and industrial activity worldwide; changes in currency translation rates; international and domestic political instability; interest rate fluctuations and changes in credit markets; global sourcing of materials; interruptions of or intrusions into our information systems; intellectual property rights; the use of generative artificial intelligence; conducting business internationally; catastrophic events; our ability to attract, develop and retain qualified personnel; public health crises; our growth strategies and acquisitions; potential goodwill impairment; our ability to compete effectively; our dependence on a few large customers; our dependence on cyclical industries; changes in laws and regulations; climate-related laws, regulations and accords; environmental, social and governance-related expectations and requirements; compliance with anti-corruption and trade laws; changes in tax rates or the adoption of new tax legislation; and costs associated with legal proceedings. Please refer to Item 1A of the 2023 Annual Report and Item 1A of this Form 10-Q for a more comprehensive discussion of these and other risk factors. These reports are available on the Company’s website at www.graco.com (http://www.graco.com) and the Securities and Exchange Commission’s website at www.sec.gov (http://www.sec.gov). Shareholders, potential investors and other readers are urged to consider these factors in evaluating forward-looking statements and are cautioned not to place undue reliance on such forward-looking statements.

Investors should realize that factors other than those identified above and in Item 1A might prove important to the Company’s future results. It is not possible for management to identify each and every factor that may have an impact on the Company’s operations in the future as new factors can develop from time to time.

Evaluation of disclosure controls and procedures

As of the end of the fiscal quarter covered by this report, the Company carried out an evaluation of the effectiveness of the design and operation of its disclosure controls and procedures. This evaluation was done under the supervision and with the participation of the Company’s President and Chief Executive Officer and the Chief Financial Officer and Treasurer. Based upon that evaluation, the Company's President and Chief Executive Officer and the Chief Financial Officer and Treasurer concluded that the Company’s disclosure controls and procedures are effective.

Changes in internal controls

During the quarter, there was no change in the Company’s internal control over financial reporting that has materially affected or is reasonably likely to materially affect the Company’s internal control over financial reporting.

PART IIOTHER INFORMATION