Graco Inc 2026 Q3 Earnings Call

I'm here with Mark Sheahan, our President and Chief Executive Officer, Sanjiv Gupta, Chief Financial Officer and Treasurer, and Chris Knutson, Vice President, Chief Accounting Officer and Controller. We welcome you to our conference call to report Graco's fiscal 2026 third quarter results. Before we begin, I'd like to remind everyone that certain statements made during this call may be forward-looking and are subject to risks and uncertainties. Please refer to the safe harbor statement included in our earnings release and earnings presentation, as well as our SEC filings for additional information regarding these risks and uncertainties. I will now turn the conference over to Mark Sheahan.

Thank you, John, and good morning, everyone. Before turning to our quarterly results, I wanted to just highlight the technology agreement we announced yesterday with our ETM business and ABB. Under this agreement, ABB will license ETM's patented transverse flux motor technology for use in data center cooling towers, heat rejection systems, and related thermal management applications. The agreement builds on our existing collaboration with ABB in industrial applications, and it creates an opportunity to participate in one of the fastest-growing infrastructure markets in the world. As demand for AI, cloud computing, and high-density data centers continues to grow, cooling performance is becoming increasingly important to energy efficiency, reliability, and operating costs. We believe ETM's direct drive motor technology is well-positioned to address those needs by reducing mechanical complexity and improving the overall system performance.

Just as importantly, ABB's decision to expand its relationship with ETM and Graco is a strong validation of the technology, the team, and the commercial opportunity ahead. By combining ABB's global scale, customer relationships, and manufacturing capabilities with ETM's differentiated technology, we have a unique opportunity to create value in a large and growing market while further demonstrating the long-term potential of the ETM platform. Based on current development timeline, the companies are targeting the first data center installations by the end of 2029. Turning to the quarterly results. We delivered another strong quarter with record sales of $586 million, an increase of 8% compared to last year, including organic growth of 4%. The growth was broad-based, with all three segments and all reportable regions contributing. Importantly, the growth was supported by improving order activity.

Organic incoming orders increased 7% in the quarter, and they were up 4% year to date. Backlog as of October 16, excluding acquisitions, increased $51 million or 18% from the beginning of the year. That provides us with improved visibility as we enter into the fourth quarter. During the quarter, we completed the acquisition of Valco Melton, which expands our precision adhesive dispensing and quality assurance capabilities. We are excited about the meaningful revenue and operating synergies available across the combined businesses. Our integration priorities are to enable cross-selling through our complementary customer relationships and channels, to leverage procurement and manufacturing capabilities, and to preserve customer service and business momentum. We are targeting expansion of Valco Melton's EBITDA margin from the high teens to the mid-20 range within three years of closing. Turning to the segments. Our contractor segment delivered sales growth of 5%, including acquisitions and organic growth of 2%, with growth across all of the regions.

Results were led by professional paint in the Americas, where customer adoption of new products like QuickShot II and ProReach contributed to healthy sell-through in key channels. The results reflected strong commercial execution and growing demand for our products. Infrastructure spending and commercial construction activity are also contributing to the segment's momentum. Across the segment, bookings increased 7% in the quarter and 2% year to date, supporting demand entering the fourth quarter. The industrial segment delivered 11% sales growth in the third quarter, reflecting contributions from the core business and acquisitions. Growth was led by project activity and powder finishing systems, while customer spending on maintenance and repair remained strong.

We also saw increased adoption of electric technologies, including the QUANTM pump in process manufacturing applications and continued growth in automatic lubrication. Overall demand remains steady, with year to date bookings up 1%. At the same time, customers continue to take a measured approach to certain larger capital projects, resulting in longer decision cycles in some applications. Expansion market segment sales increased 8% during the quarter. Semiconductor delivered the strongest quarterly revenue in several years as customers invested in advanced manufacturing capacity and more complex production processes. These requirements are expanding the range of applications served by our high purity and precision technologies. Environmental also delivered double-digit growth during the quarter. Bookings in this segment increased 62% in the third quarter, and they are up 44% year to date. Turning to the outlook. We expect fourth quarter revenue of $610 million-$640 million based on current order trends and backlog.

Order activity supports our outlook, although demand conditions vary across our markets and larger project schedules can shift revenue between periods. Our priorities are to convert orders into shipments advance new product adoption, manage cost pressures, and capture acquisition synergies while maintaining customer service. With that, I will turn the call over to Sanjiv to provide more detail on our financial results for the quarter.

Thank you, Mark, and good morning, everyone. I will provide some additional detail on our third quarter financial performance, profitability, and cash flow. We reported record Q3 revenue of $586 million. As we discussed last quarter, our third quarter revenue guidance was $580 million to $600 million, excluding Valco Melton. On a comparable basis, third quarter revenue finished slightly below that range, primarily within the Industrial segment, reflecting the timing around larger capital projects, including longer decision cycles and some projects being delayed or pushed out. Importantly, we are not seeing broad-based deterioration in demand, as indicated by order trends. Our fourth quarter outlook reflects current business conditions and the timing of converting order activity and backlog into revenue. Our outlook does not assume an acceleration in demand during the fourth quarter. With that context, let me turn to profitability in the third quarter.

Adjusted operating earnings came in at $161 million, and adjusted earnings per share grew 5% to $0.81. Realized pricing was able to offset higher net input costs, and we maintained good expense discipline while continuing to invest in our strategic growth initiatives. Adjusted operating margin was 27% of sales, down nearly 180 basis points from the prior year quarter, primarily due to the product and channel mix, including a higher mix of powder finishing system. This was partially offset by disciplined cost management, with operating expenses down approximately $3 million, excluding acquired expenses, amortization, acquisition-related costs, and the prior year contingent consideration benefit. Contractor operating earnings at $71 million rose 5%, with stable margins versus last year.

Excluding Valco Melton and related costs, operating earnings for Industrial were flat at $74 million, with margin down nearly 1% from the same quarter last year, due primarily to product and channel mix discussed earlier. Expansion Markets operating earnings at $11 million increased 5% on semiconductor strength, despite a tough comparable to the prior year, which included upfront license fee in our electric motor product application that did not repeat. Turning to cash flow, we generated $463 million of operating cash flow year to date, representing 116% of adjusted net earnings. We continue to deploy capital in a balanced manner. For the year to date, we repurchased shares for $467 million, paid $145 million in dividends, invested $436 million in acquisition net of cash acquired, and invested $48 million in capital expenditures. Even after funding these investments, we continue to maintain a slightly positive net cash position.

In summary, our third quarter performance reinforces the strength of our operating model and cash generation. We remain well positioned to invest in strategic growth opportunities while maintaining a disciplined approach to capital allocation and long-term shareholder value creation. That concludes our prepared remarks. Operator, we are ready for the questions.

Hi, Mike. Hey. Could you unpack the contractor piece a little bit for me, maybe by channel with on the more traditional resi commercial side, what you're seeing with the foam business, and any signs of deceleration in growth rates, not necessarily environment, maybe that too, but any signs of deceleration or worsening trends in any of those sub-areas within that segment?