Graco Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2024

There are 11 speakers on the call.

Operator

Good morning, and welcome to the Third Quarter Conference Call for Graco Inc. If you wish to access the replay for this call, you may do so by visiting the company's 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 question and answers after opening remarks from management. During this call, various remarks may be made by management about their expectations, plans or prospects for the future.

Operator

These remarks constitute forward looking statements for the purpose 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 2023 Annual Report on Form 10 ks and in Item 1A of the company's most recently 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 as of the time they are made. The company undertakes no obligations to update these statements in the light of new information or future events.

Operator

I will now turn the conference over to Chris Knutsen, Executive Vice President, Corporate Controller.

Speaker 1

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 call over to Mark for additional commentary. Yesterday, Graco reported 3rd quarter sales of $519,000,000 a decrease of 4% from the same quarter last year. Reported and adjusted net earnings decreased 8% to $122,000,000 or $0.71 per diluted share.

Speaker 1

Excluding the impact of excess tax benefits from stock option exercises, the impairment charge and contingent consideration adjustment recorded in the Q3 of 2023, adjusted non GAAP net earnings per share decreased 7%. The effect of currency translation had no significant impact on sales or net earnings for the quarter. The gross margin rate increased 50 basis points in the quarter. Realized pricing was more than enough to offset sales volume declines occurring in all segments. While product costs were lower for the 1st 9 months of the year, they were a headwind in the quarter as our production volumes primarily in contractor have declined.

Speaker 1

We expect these headwinds to continue for the remainder of the year. Total operating expenses increased $9,000,000 or 7% in the quarter, mainly due to new product development spending, growth initiatives and other corporate items, including the relocation to a new distribution center. Reductions in volume and earnings based expenses of $3,000,000 partially offset this increase. Gross margin rate improvement was unable to offset lower sales volumes and increased expenses during the quarter resulting in an operating margin rate of 28%, a decline of 2 percentage points from the same period last year. The Process segment operating margin rate decreased 4 percentage points to 27% due to the impacts of higher spending and decreased volumes compared to the Q3 last year.

Speaker 1

Interest and other benefits increased $4,000,000 during the quarter, driven primarily by lower interest expense as our long term debt was repaid in 2023 in addition to increased interest income on cash held. The adjusted effective tax rate was 19%, which is consistent with our expected full year tax rate of approximately 19.5% to 20.5% on an as adjusted basis. Cash provided by operations totaled $436,000,000 for the year, a decrease of $55,000,000 from last year, driven mostly by inventory purchases related to new product launches, timing of estimated tax payments and lower net earnings. Cash provided by operations as a percent of reported net earnings is 116% for the year. Significant year to date uses of cash included repurchases of 399,000 shares for $31,000,000 dividends of $129,000,000 and capital expenditures of $93,000,000 of which $60,000,000 related to facility expansion projects.

Speaker 1

These cash uses were offset by share issuances of $45,000,000 A few comments as we look forward to the remainder of the year. Based on current exchange rates assuming the same volumes, mix of products and mix of business by currency as in 2023, movement in foreign currencies would have no impact on net sales or net earnings for the full year. Our full year estimates for unallocated corporate expense and capital expenditures remain unchanged and can be found in the conference call slide deck on Page 10. Finally, effective January 1, 2025, we will move to a global customer centric operating structure with 4 business divisions: Industrial, Powder, Expansion Markets and Contractor. At that time, our regional teams, which previously operated independently, will be integrated into the business divisions.

Speaker 1

The current industrial and lubrication equipment divisions along with the process transfer equipment business that is part of the process division will be combined to form the new global industrial division. The Powder Division, which is currently structured as a global business, will continue to operate as it does today and will combine with the Industrial Division to form the Industrial Reporting segment. The New Expansion Markets Division will focus on driving inorganic growth in new or adjacent markets. Our existing environmental, semiconductor, high pressure valves and electric motors businesses together with select future ventures and acquisitions will reside within this newly formed division and reporting segment. The contractor division will be restructured to serve the needs of our global customers and will remain unchanged as a reporting segment relative to prior periods.

Speaker 1

We will report financial results under these new segments for the Q1 of 2025. We will provide recast segment financial information in connection with our Q4 earnings release as supplemental information. I'll now turn the call over to Mark for further segment and regional commentary.

Speaker 2

Thank you, Chris. Good morning, everyone. I'd like to begin by discussing our recent announcements. In September, we announced our One Graco initiative focused on driving global growth, greater profitability and operational efficiencies. Starting in 2025, Graco will adopt a new global structure with a commercial focus enabling our sales, marketing and engineering teams to focus squarely on revenue growth.

Speaker 2

This new customer centric approach focuses on segments with similar needs, helping us scale more easily as we grow and enhance our customer experience. The strategy builds on the success of our powder coating business and aligns well with the integration of protective coatings and spray foam businesses into the Contractor division a few years ago. The new structure also strengthens our ability to pursue M and A opportunities through both our legacy divisions and the newly created Expansion Markets division, enabling us to target significant acquisitions in current and adjacent markets. As we establish our new market oriented global structure over the coming months, I have full confidence in our experienced leadership team and dedicated employees to navigate this change successfully. During the quarter, we also announced the acquisitions of PCT Systems and Khorab.

Speaker 2

PCT Systems, which provides megasonic and ultrasonic wet cleaning systems, complements our existing high purity chemical delivery equipment used in semiconductor and electronics production. Although the PCT acquisition closed during the quarter, it did not have a material impact on quarterly results. We also reached a definitive agreement to acquire Khorab, a global leader in high-tech dispensing and mixing solutions for paints and coatings. This acquisition enhances our strong position in the growing paint and coating machinery manufacturing category within the contractor division, while expanding our global manufacturing footprint. We expect the Khorobe acquisition to close in the Q4 and the combined annual revenue of these acquisitions is nearly $130,000,000 We're very optimistic about these opportunities and confident in our ability to leverage the complementary strengths of these businesses to drive growth and create value for our customers and shareholders.

Speaker 2

Moving on to our financial performance. All of my comments will be on an organic constant currency basis. Sales in the Q3 were down 4% with declines in all segments except industrial, which was flat. Industrial Finishing Systems sales in the Americas and EMEA offset steep declines in Asia Pacific, especially China. Declines continued in the Process segment with weakness noted in the semiconductor and mining markets.

Speaker 2

New product introductions in the Contractors segment have been well received and global protective coatings markets are strong. The decrease in China revenue across the industrial and process segments accounted for more than 90% of the overall revenue decline in the quarter and over 60% year to date. This represents broad based weakness and overcapacity across key end markets including automotive, battery, solar, semiconductor and electronics. Incoming order rates in the Q3 continued to be difficult worldwide as all major product categories with the exception of our powder finishing business saw order rates decline compared to the Q2 of this year. Weak demand continued in the Asia Pacific region, especially in China.

Speaker 2

These reductions have been consistent throughout the year. Demand in North America also softened during the quarter impacting all segments. In contrast, over the past 6 weeks, our consolidated global incoming order rates have shown improvement compared to the same period last year, experiencing 11% growth. This double digit increase is primarily driven by both the Industrial and Process segments. While this is a relatively short time period, it gives us optimism for the remainder of the year.

Speaker 2

Now turning to some commentary on our segments. Contractor sales were down 1% in the Q3. Protective coatings grew across all regions, but it wasn't enough to offset softness in the propane and home center channels. Asia Pacific was a bright spot as the container market showed continued improvement after minimal activity last year. Response to new products continues to be favorably received and inventory levels within the channel are considered normal.

Speaker 2

We have additional new products targeted to be launched prior to the end of the year, which should also have some positive impact for the Q4. Industrial sales were flat in the quarter as strong finishing system sales in both North America and EMEA were offset by heavy declines in Asia Pacific. Revenue in the Americas was higher for the Q2 in a row led by the timing of finishing system sales along with increased activity across the liquid finishing and sealants and adhesive businesses. The team remains positive as quoting activity remains stable. However, CapEx investments are being delayed as end users are taking a wait and see approach.

Speaker 2

Moving on to the Process segment. Sales were down 12% compared to the same quarter last year, primarily due to continued weakness in the semiconductor and mining markets along with a slowdown in vehicle service business. The decline in sales volume is primarily is the primary driver of the decrease in profitability with decremental margins of nearly 60% for the quarter. Moving on to our outlook. Overall, conditions remain challenging as we continue to experience soft demand trends in many of our core markets.

Speaker 2

We're encouraged by the increased order activity so far in the Q4 and we have confidence in our new product lineup. However, it's still too early to know if these order rates will continue to the end of the year. As a result, we're maintaining our full year revenue guide of low single digit decline on an organic constant currency basis. That concludes our prepared remarks. Operator, we're ready for questions.

Operator

Thank you. Our first question is going to come from the line of Deane Dray with RBC Capital Markets. Please proceed.

Speaker 3

Thank you. Good morning, everyone.

Speaker 4

Hi, Deane. Good morning.

Speaker 5

Maybe we could start with the usual tour by end market and by region, obviously more of a focus on APAC, that 90% data point where the shortfall was that's, kind of what's going on there ground level. I do notice there's no change in the traffic light chart. You were already at red lights in APAC for industrial and process. So maybe start with that tour end market and region and where the surprises were?

Speaker 2

Yes, we're red. We couldn't make it any more red. So it's been red. It's kind of been flashing that way for a while for us. I mean, China sales, we wanted to highlight those because we really do feel like that has been the main area where our businesses experienced the softness this year.

Speaker 2

Again, Q3 China sales were down about $10,000,000 for industrial and process and the total AP sales were down $11,200,000 So really all of the decline is coming in those 2 camps within China and kind of the same story on a year to date basis. If you look across the end markets there, for sure automotive is down compared to last year. The construction area is actually up a little bit for us because of what we've got going on in the container industry. So CED actually grew, which was nice to see. But really all of the other big markets in China, whether it's mining, battery production, solar, electronics, they're all experiencing headwinds this year compared to what we've had in the past.

Speaker 2

Positively, Japan seems to be doing pretty well. Korea is hanging in there and we're also seeing growth in India. So it really is kind of a China story. I think we need to get through the end of the year here and then hopefully we can grow off of a lower base there.

Speaker 5

And how about the other regions?

Speaker 2

Europe hanging there pretty well across really all of the different product categories. We had decent activity in industrial, process and contractors. So on an overall basis, while the revenues were down compared to a year ago, kind of that low single digit decline really doesn't cause us a whole lot of concern. We did see nice activity in North America, really driven by some of the larger projects that we had on the finishing system side of the business that freed up in the quarter that we were able to deliver and get customer recognition for. So, I would probably characterize as the North American market seems decent, Europe okay and Asia Pacific market has been really challenging for us.

Speaker 5

That's good on U. S?

Speaker 2

Yes. I mean North America really is primarily U. S.

Speaker 4

Got it. On that I would say and talking with our teams here in North America, they've called out over recent months, good activity in defense, the solar market interestingly here in North America, which is soft in Asia. Despite the challenges in the industry, aerospace, electronics and even automotive in both the legacy and the EV manufacturers are pretty good markets for us.

Speaker 5

Good. And then just as a follow-up, Mark, you and I talked about this at our RBC Industrials Conference a few weeks ago. Just the genesis of the resegmentation, the why now, how did you land in these 4 categories? And from is it still too early to talk about where and how the growth can be? You'd see some sort of improvement and just where and how would you be measuring those benefits?

Speaker 2

Yes. So I think the Genesis was really this spring when our team got together and looked at some of the data and really figured out that we weren't growing as much organically as we thought that we could. And we felt like some of the structural barriers that we have put up as a team and the silos by creating divisions that had their own factories and their own marketing teams and their own engineering teams and approaching our channel partners individually versus trying to leverage as a one Graco approach was really what we started with. We commissioned a group of leaders that were not direct reports of mine, but these were our high potential people within multiple business and regional units to take a look at the structure and come back with some recommendations. And after a few iterations with my team as well as the Board of Directors, we really landed on the One Graco approach.

Speaker 2

I think it will result in some efficiencies, just in terms of our ability to target customers, with the entire product line versus on a division by division basis. And, we'll also reorient us a little bit more towards looking at the key customer constituencies and a number of business units. It's interesting because the end users, the customers in process, industrial and LED in a lot of cases are very similar. You go into a factory and you're dealing with the guy that's actually running the machine, you're dealing with the factory manager, you're dealing with an engineer, you're dealing with procurement people and being able to go in with a one Graco approach with the full product line, we think is going to have a lot of value versus having multiple teams interact with those customers as well. So it's not going to flip a switch overnight.

Speaker 2

And as I think I told you, no structure is perfect, but we really do believe that after running the current playbook for more than 20 years, it was time to take approach and we're all excited about the prospects that the 1 Graco will have.

Speaker 5

Yes. That's great color and best of luck. Thank you.

Speaker 2

Thanks.

Operator

Thank you. And one moment for our next question. Our next question is going to come from the line of Mike Halloran with Baird. Your line is open. Please go ahead.

Speaker 4

Hey, good morning, everyone.

Speaker 2

Hi, Mike.

Speaker 6

So a couple of questions, Just kind of following up on that last. At the end of the day, this seems more the restructuring you're doing here seems more like a driver for growth. In the past, you've talked about kind of the 5.5% kind of growth, maybe adding 5% kind of growth last cycle, being able to maybe add an incremental point of growth to that. Is that really what the goal here is from a loose quantification? And then secondarily, is there

Speaker 5

a margin benefit you think you're going

Speaker 6

to drive from this as well with how you're moving things around globally?

Speaker 2

Yes. For sure, growth is the driver behind this. Again, as I said, our team got together and we look at the numbers and we felt like we could just do a better job. And so that was kind of the genesis of this change that we're going through. I guess the other piece that I didn't mention is that we also created a new group called Expansion Markets that will be not only managing some of the businesses that we've acquired over the last few years, but we'll also be looking for adjacent markets that are near those businesses and new sandboxes that we might potentially play in as a company.

Speaker 2

I really felt like we didn't have anybody at Graco that was focused on that. And I think that there are other areas outside of our current businesses that we can play in on the M and A front. And so we'll be doing some work there as well. I think it gives us maybe a better chance at being able to put points on the board from an M and A standpoint. Our divisions are still going to look at the stuff that they've always looked at and our pipelines look pretty good there.

Speaker 2

But having that group looking at those things, I think, is going to be a change compared to what we've had in the past. In terms of efficiencies, yes, there will be some. I think for now what we're doing is we're working through the details of what the new structures are going to look like. We're going to hit the ground running on January 1, and I think we'll be ready to talk about efficiencies and what we expect to see after we're done with the work, most likely when we make our year end announcement and talk with you guys at that point. We don't have specifics yet that I'm comfortable sharing with you, but we are looking to drive both top line and bottom line growth with some of these moves.

Speaker 6

Makes sense. And then kind of a 2 fold question here. First, obviously, we're late in the year here, so your guidance, you can kind of get some implied growth for the Q4 here, but it's a pretty wide range. So the first question is basically, are we talking about a 4th quarter growth rate that is similar to this low single digit guide for the full year? And then related, could you just put what's going on with the backlog and the orders in context and help us understand how that's flowing through things as it sits here?

Speaker 2

Yes. I think the guide is pretty consistent with what we've had now for a couple of quarters, I guess, where we're targeting this low single digit constant currency revenue decline. So you guys can do the math on that, but I think it would play out that that's likely what you're going to see in Q4, what we saw in Q3 and kind of for the year to date number as well. We have experienced quite a bit of backlog reduction. I remember in our backlog was $450,000,000 now it's $230,000,000 So, we're at the point now where we're back to, I call it, a normal business for Graco, mostly book and ship with a couple of exceptions, one being our powder coating business where we do have some backlog there and then our some of our longer term projects in the industrial side as well.

Speaker 2

But in terms of where we're at on backlog, I think we're at a point now where you should expect to see this number kind of hang in there going forward barring any kind of crazy stuff like we had a couple of years ago where everybody was placing all kinds of orders. So it does create some headwind for us as you know, I'm sure. When you look at 2023 versus 2024, that backlog came down in 2023, it's come down in 2024, but not quite as much. As we look at 2024 into 2025, if we're assuming that we're at normal levels, we won't have this built in reduction in backlog. So we factor all that into the guide that we give you guys.

Speaker 2

We're comfortable with it at this point and we hope that we're able to hit it by the end of the year. And then as we get to 25, obviously, we'll update our outlook at that point.

Speaker 6

Thanks, Mark. Appreciate it.

Speaker 3

Yes.

Operator

Thank you. And one moment for our next question. The next question is going to come from the line of Saree Boroditsky with Jefferies. Your line is open. Please go ahead.

Speaker 7

Hi, good morning. The gross margin performance was really strong in the quarter, up year over year despite the lower volumes. Can you just talk about the contribution of price costs or other productivity drivers that helped offset that lower factory volumes?

Speaker 4

Well, I think this is David. I think the starting point is certainly the effectiveness we've had in realized pricing really now for 2 full years because we did our interim adjustment, I think, in the middle of 2022. And one of the consistencies in our favorable price cost relationship since has been what we've achieved in pricing. Admittedly, the increases we saw in the second half of twenty twenty two and all of twenty twenty three were a bit more dramatic than what we're seeing today. But it's been consistent straying a bit.

Speaker 4

Input costs have leveled out, but they certainly have not declined to levels that we saw in any meaningful way in periods prior to 2021 and earlier periods. So we are working with a higher cost structure, both for input costs, labor and energy and other things, but we're covering those. I think a maybe more recent development that has had impact on us is some less ability to absorb all the factory overhead because of the, call it, the decline in unit volumes that we touched on in our opening comments. But with that said, the overall price cost has remained positive.

Speaker 2

Yes, I'm pretty happy with the factory performance, given the fact that we've had volume declines to actually have the margins go up. I would say that we are locked and loaded from a production standpoint in our ability to react when volumes do pick up. We feel like the business is in great shape. And once we get the volume growth, the leverage is going to be really nice to see.

Speaker 7

You mentioned incoming orders over the last 6 weeks up, I believe, 11% with growth in industrial and process. Could you just kind of dive into that a bit? What markets or regions are driving this? And then as you think about North American Industrials, you mentioned the timing of finishing sales. It just seems that odd with commentary, from a CapEx pause.

Speaker 7

So could you just help us understand what's driving the strong demand?

Speaker 2

Yes. I think the growth in orders over the last 6 weeks, again, pretty short time period have been broad based, with the exception of Asia, which is still challenging to us. So and we want to just point out that it was mostly in the industrial and process segments, which have been the ones that have been really creamed this year when it comes to the declines that we've seen in that particular region. So I wouldn't read too much into it other than we thought it was an interesting data point to share with you. We want to be as transparent as possible and it will hopefully give you a little bit more confidence in our full year revenue guide of down low single digits for the full year.

Speaker 2

When it comes to the North America industrial business, we did we were able to recognize some larger project activity that was previously booked after customer sign off, particularly in the powder industry. And so that really did help drive the growth. If you were to sort of strip that out, you would probably see something similar in North America industrial to what we're seeing in Europe from total demand standpoint, if that's helpful.

Speaker 7

Appreciate the color. Thank you.

Operator

Thank you. And one moment for our next question. Our next question is going to come from the line of Matt Summerville with Your line is open. Please go ahead.

Speaker 8

Thanks. Within the Process business, it looks like the decrementals have been worsening on a year to date basis. Is there something else that's maybe fallen off there when you look at sequentially how that business performed? Just help me understand a little bit of the puts and takes from the top and bottom line.

Speaker 1

Matt, this is Chris. Looking at that business, the decrementals have been tough for the whole year, I would say. What we do see within that business in particular is when we do see volumes fall off in almost all of the factory locations, It really does impact the decrementals pretty hard across the board. Earlier in the year, we may have had some benefits from one of our factories having volume, which could have offset some of the costs in some of the other locations. But what we're seeing now is it's pretty broad based across all of the different business units, which is driving that decremental margin.

Speaker 2

Yes. I think the only thing I would add is that as we've kind of rolled the year here a little bit, we have seen a little bit more weaker activity in our lubrication businesses, which are really nicely profitable. And so when I look at like Q1, Q2 versus Q3, those the revenues there have come down a little bit sequentially through those quarters. The other big one obviously is the semiconductor business, which is way down from a year ago, but bookings are starting to pick up there as anticipated with the pickup that everyone's predicting for 2025.

Speaker 4

And I should leave well enough alone, but I'll add that the two points Mark mentioned also ties once again into the whole Asia Pacific arena, where semiconductor is there's a lot of activity in region and the ongoing softness there has been it's no secret, pretty dramatic. And in the lubrication space, the mining markets, not just in China, but even in Southeast Asia are a significant portion of that business. So when those markets are soft, I'd say especially in region, you see that flow through to the process segment.

Speaker 8

Got it. And then just as a follow-up, I wondered if you could maybe talk about core out for a moment. What's the historical organic growth rate of that business looked like? And what is their U. S.

Speaker 8

Presence today? And how are you thinking about being able to leverage your sort of big box relationships, we'll just generically call them to maybe bring Korob's presence to the market or lift their presence in the local market? Thank you.

Speaker 2

Yes. I appreciate the question. Given that we haven't closed the deal, I'm a little bit limited in what I can say. What I will say here's what I like about the business. Number 1, we understand the technologies.

Speaker 2

It's metering, it's mixing, it's tinting, it's stuff that Graco knows how to do pretty well. We also do like the overlap on the customers. Some of their big customers are Graco customers. I think their presence outside of North America is much bigger than it is in North America. And we are hopeful that they can help us out in the Asia Pacific region with some of the contacts they have like Asian Paints and that we can potentially leverage our good relationships at the home center customers that we have and the larger professional channel customers that we have as well.

Speaker 2

So I think there are some revenue synergies there that we're hopeful to get. In terms of their growth, historically, it's kind of been in that low to mid single digits. So it's not too dissimilar from what Graco has in terms of organic growth through a cycle. So I think that we feel pretty good about that. Lastly, what I'll say is that they have really good production in Italy and they also have a footprint in India production wise that we like.

Speaker 2

And that is an area that we've thought about expanding into for Graco to expand our presence in India from a production standpoint, given the activity that's happening there. So this gives us a footprint immediately to do that and to experiment with it. It's a little bit lower risk than if we had planted a flag somewhere and did that on our own. So I think we're excited about that as well.

Speaker 8

Great. Thanks, Mark.

Speaker 9

Yes.

Operator

Thank you. And one moment for our next question. Our next question is going to come from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is open. Please go ahead.

Speaker 9

Hey, good morning, guys.

Speaker 4

Hey, Jeff.

Speaker 9

Just wondering, I guess, as you talk to customers and you take kind of the last 6 weeks of orders, anything that sticks out that starts to feel better and kind of get you out of this right? I think you mentioned Asia still particularly challenged, but just any kind of green shoots?

Speaker 2

Yes. I think that there's obviously a lot of uncertainty out there these days and not anything you guys don't know with all these wars going on again, we thought the data point was interesting. I do think that we're starting to anniversary maybe some of the comps that we've had over the last couple of years. As I mentioned earlier, our backlogs now are kind of at levels where you would have expected them to be on a normalized basis. And so as those backlogs have come down, obviously customers start to reorder and hopefully we've seen sort of a bottoming out here and we can start to see improvement off of what's been a couple of tough years.

Speaker 4

I guess I would add, Mark touched on the fact that 6 weeks is not a very long period and this is more antidotal, but just in a recent conversation, taking a look at our EMEA space, businesses that have been okay thus far this year, for example, the protective coating part of the contractor business, especially that portion of the market that serves energy and some of the support infrastructure in the Middle East has remained strong. We have been seeing my expectations as somebody who was based in Europe years ago always is a little low on the industrial side, but there has been a fairly steady drumbeat of regular business, including the automotive markets. And finally, even in the process space, which has been struggling a bit, there has been some recent order activity that is more encouraging than what we have seen earlier in the year.

Speaker 9

Okay. And then just I appreciate the color on the 1 Graco and the new segment. But if you if we look maybe more technical on the segment changes, can you just walk through, it sounds like contractors unchanged and then we're moving a business or 2 from for process into industrial. Is it that simple?

Speaker 1

I think the way that you look at it, the way that today, Jeff, we have our industrial division and our powder division. They'll still stay in the industrial group. We'll move our lubrication and a portion of our process division into that industrial group. And the remaining businesses will break out and create the expansion markets area, which is the semiconductor, the high pressure valves and the environmental businesses?

Speaker 2

Yes. The only comment I'll make Jeff is that yes, for sure, it's just exactly as Chris described. But historically, we've operated our regions on a matrix basis where they had a separate P and L and they would make decisions based on what they thought was best for the region. We're moving to global structures where our industrial business will now manage a global P and L and they'll be able to make those decisions based on the opportunities they see. Same thing on the contractor side.

Speaker 2

We're kind of knocking down the matrixes and we're going to be running global businesses, which we're excited about. It's worked really well for us with GEMA and we think that moving to that approach with Gregor will be beneficial as well.

Speaker 9

And maybe just last one, M and A pipeline behind the two deals. And would you expect that particularly more focus is going to be in this expansion markets? Or do you think you're still looking pretty broad based?

Speaker 2

Well, our pipeline that we have has been built up historically by the division. So if I look at the pipeline, I've got about 100 companies in there that we are talking to active kind of ones that we would consider acquiring if they became available. And so we have good momentum there and I think the market is a little more favorable today than it was a year ago. And so I'm hopeful that we will see some activity coming from that pipeline that we've already got. Expansion markets, to the extent that we've got businesses already, they have names in the pipeline that they will pursue.

Speaker 2

But in addition to that, we're also going to challenge that group with doing more research outside of our existing markets and find some spaces that maybe our divisions haven't looked at and see if there's opportunities for Graco to expand into those as well. We don't have any targets, but I do feel really good about the fact that now we're going to have a group that is charged with that kind of a responsibility beyond just looking at things that are really closely adjacent to us.

Speaker 9

Okay. Appreciate it, Mark. Yes.

Operator

Thank you. And one moment for our next question. Our next question is going to come from the line of Andrew Buscayagoula with BNP Paribas. Your line is open. Please go ahead.

Speaker 3

Thanks. Yes, so I wanted to touch on within Contractor, you got these you have these new products, new product cycle rolling out. We haven't seen much acceptance from it yet, it seems, but you're saying there's more products seen coming out in Q4. Is that informing your guidance that you guys maintaining your guidance? Do you see anything in your orders that you see, greater sales in that area?

Speaker 2

Well, I think we've done really well with our new products. So I would say that they've driven a lot of incremental revenue in a market that's not been great. So I mean, if you look at the macro factors in the housing market in North America, for example, they're still flashing kind of red, yellow signs. And the fact that we're we were flat through the 1st 6 months in Contractor and we're flat in Q3, I think it's been fairly consistent. It's always hard for us to know exactly what would have our revenue been if we didn't have the new products.

Speaker 2

But we all feel like if we didn't have those new products, you would see different numbers than what we've reported. As we get into Q4, I think it's not going to be like a big step change. We are excited about some of the products that are coming out in Q4, but I don't know that they're going to have a meaningful impact over a 13 week time period. And yes, that definitely did inform our decision on what we wanted to do for the guide for the full year.

Speaker 3

Okay. Yes. Mark, you're talking more about interesting kind of M and A. Are we looking into like brand new end markets you don't play in yet that are maybe not less correlated with what you guys do? Or is it brand new products available before that you're trying to get into?

Speaker 3

It seems like a slight change versus the past.

Speaker 2

Yes, it is a change and we'll see how the thought unfolds here. But I mean, there's a lot of fluid handling opportunities in markets that Graco doesn't play in and I think we've got a lot of expertise there that we can bring. We've got great engineers. We know how to manufacture stuff. We've got a global footprint.

Speaker 2

We have customers that have some of those needs that we don't really address today. So we'll be challenging our teams to run the numbers, look at the opportunities and see if there's anything for us there that we haven't really looked at in the past.

Speaker 3

Okay, interesting. All right. Thank you.

Operator

Thank you. One moment for our next question. Our next question is going to come from the line of Walter Liptak with Seaport Research. Your line is open. Please go ahead.

Speaker 10

Hi, thanks. Good morning everyone. So I wanted to ask a follow-up on China. You talked about the industrial and process having some headwinds and the $10,000,000 of some fall off in Industrial and Process. So I guess the question is, what are we thinking about like with their quoting in their funnels?

Speaker 10

What does it take to get the China business? Are we looking for macro things like the government stimulus that's going on? Or how should we think about sort of the near term outlook?

Speaker 2

Yes. I think there's been over a little bit of overcapacity built over there in the last couple of years. So I think there's some catch up that's going on because if I look at what's happening in our end markets, it's really kind of across the board and most of the big ones. It's not like it's limited to any one particular thing. If you look at semiconductor, they're down, automotive is down, battery is down, solar is down.

Speaker 2

So, I do feel like over the last few years, they've built a lot of capacity. What's going to change hopefully at some point we get to an equilibrium level and then business conditions are a little bit better for us in China than what we've had over the last 12 months or so. I don't think that this stimulus is going to have a meaningful impact in the short term. We'll see what happens, but we certainly haven't seen it so far in our results.

Speaker 10

Okay, great. It's been a couple of quarters that we've been talking about China now. So is it going to be more of the same you think until we get easier comps in the back half of next year or when do the comps get easier?

Speaker 4

Well, I would say that the continent about overcapacity is right. And here's where you have to go from, I think generalizing about the economy to specific markets. As an old industrial guy, I'm hopeful that there still is going to be lots of interesting investments, I believe this, in battery and electric vehicle and some of the traditional markets where we've been. There are certain markets, for example, the construction sector that would suggest, there could be, a downturn that could go on for quite a while. If you believe some of the reports that have come out in recent months where you have millions of units that have been constructed that are empty.

Speaker 4

And I think that could play that's going to take more than a liquidity confidence a liquidity program to drive the kind of confidence that our sorts of end users are going to need to make big investments in that space.

Speaker 10

Okay, great. And then on the new segmentation, it looks great focused on growth. Can you give us an idea of what the expansion markets with that growth rate you think might look like?

Speaker 2

Well, the organic growth of those segments isn't going to be vastly different from the organic growth at Graco. There's a little more volatility in there with semiconductor that you'll see from quarter to quarter. But again, the trends there right now look to be pretty favorable. The real piece that I can answer is the inorganic side and hopefully again the team does some work. It's going to take time.

Speaker 2

We're going to be disciplined when it comes to deploying our capital, but over time, we're hopeful that that will become a more meaningful piece of the overall Graco equation.

Speaker 10

Okay. All right, great. And as you've gone through this process, could there be divestitures that shake out from it or do you feel pretty good about all the P and Ls that are in your business?

Speaker 2

I think we like what we've got, but obviously our team will be looking at all different opportunities and what makes sense. And right now, there's no obvious things that we think we need to get real.

Speaker 10

Okay, great. Okay, thanks so much.

Operator

Thank you. If there are no further questions, I will turn the conference over to Mark Sheehan.

Speaker 2

All right. Well, that wraps it up for today. I appreciate everybody dialing in this morning and look forward to seeing you here in Q4 and during next quarter's call.

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Earnings Conference Call
Graco Q3 2024
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