Graco Inc. (NYSE: GGG) - CFO & Director of Finance, IR, & FFPA - Gabelli PVW Symposium

Thank you, Kevin. I want to thank our friends at Gabelli for the invitation to participate in this, the 35th Annual Pump, Valve, and Water Systems Symposium. It's been our pleasure to participate in this program over the years on several occasions, and it's one of our favorites. Mercifully, I won't give you a prepared presentation; Q&A is far more interesting. But I did think I would just give you a 90-second thumbnail of Graco if you're not familiar with us. Graco Inc. was founded 99 years ago in Minneapolis, Minnesota, and its original business was designing and manufacturing lubrication equipment for the automobile industry. We extended our industrial exposure into many niche markets, usually by leveraging technology we developed in one industry or application group and stretching it over other businesses. If you're looking for a quick way to think about the company, maybe we handle difficult-to-handle fluids, and you could think of expensive materials. Our growth over this century has been mostly organic. As you will see if you look at our financials, we report in three segments, but that's really deceiving. Our business is in 15 to 18 niche markets; that's how we think about our business on a daily basis. It's sometimes why you'll find me hesitant when you ask me to generalize about what's going on, because we're balancing a lot of businesses. The businesses we're in — I'm going to try to generalize — we like business-to-business, we like businesses that are global, we like recurring revenue, and we like, in our terminology, critical applications. Because business-to-business people will pay you well if you offer them durable, high-quality solutions. Our customers are return-on-investment driven, as in fact we are. It's part of our culture, and I think quite frankly it's reflected in our operating returns and our cash flows over many, many years. We have an interesting manufacturing footprint. While we are a global company, more than 80% of our manufacturing is here in the US. Last year we did just a little over $2 billion in revenue, and we've been public since 1969.

Okay, that's a good question. The transaction Kevin's referring to is the Corob manufacturing products business out of Northern Italy. It manufactures a variety of machines that are used in the mixing, shaking, tinting activities in the colorant marketplace — in other words, making paint the right color to match existing or desired color shades. This business characterizes a lot of things that we like about these niche markets we're in, as well as with respect to deal strategy. The way we like to think about opportunities in this space: the businesses we're in, these niche markets, most of them are not particularly large markets. They're sub-billion dollar markets; in some cases, they're just a few hundred million dollars. They may grow at GDP, they may grow with technology and good pricing a little above GDP in this business-to-business environment, but they're not huge and they're not exceptional growers. So you're thinking, what's not to like? What we like about that is it means the industry is relatively stable. You know who the competitors are. New competitors typically don't come into these specialized markets, and especially corporate industrial behemoths that could own the whole market and it wouldn't mean anything to them. We like that. I joined the company 30 years ago; the competitors we were talking about in those days are the same competitors we're talking about today. That's the way the Corob market is. There are two large global players: Corob is one, a business called Fluid Management that's part of a company you may have heard of, IDEX, is another one, and then there are a few regional and local players. What we liked about this business — and then I'll try to talk more broadly — is that we know the channel and the end users. Think home centers, think paint stores, people that are transacting involving paints and coatings. That's our world anyway, and we think we have opportunities to capitalize on where they're strong and where we're strong. Corob's operational footprint is very interesting. Their very much state-of-the-art manufacturing location in Northern Italy is highly mechanized, very competitive on a global basis, and absolutely first rate. We would consider it the quality of a Graco factory. They also have a very interesting footprint in India, where we really have, other than a warehouse and a sales arm, no activity there. They have a longtime and experienced manufacturing operation and a local sales and service network of a couple hundred people across the country that gives them very interesting coverage. Flip it around: here in North America, which is our core business for most of our contractor products, we have a very well-developed sales and technical organization, not to mention tremendous coverage with channel partners like the largest home centers and the largest paint chains, and we think we can do some things for them there. Lastly, this was not an initiative that was done with an auction process. This business was privately held; in this case, it was held by private equity. Through contacts in the industry, we established a working relationship with the owner, and over a period of nine months got to see the operations, got to know management, got to understand the dynamics better than we think we would have in the auction process, and we were very comfortable when it came time to close the sale. More broadly, we have a responsibility to be good stewards of capital. When we talk about our capital deployment process, number one is we like the businesses we're in, and we're always going to be big on the organic side. We are committed year in and year out to product development; we invest about 4% a year in that level of activity. We think it's important because in business-to-business environments where people are looking for ways to improve their productivity and their ROIs, the best bounce trap wins if you can get it into people's hands at high enough quality and you can support it afterwards at a reasonable price. After that, our factories — we really believe in state-of-the-art manufacturing facilities. When you visit one of our factories — we have four in the greater Minneapolis area, not exactly the place you would think of as a major hub of manufacturing — there are state-of-the-art machine tools, robotics. How have we stayed competitive? By manufacturing in the United States, lots of automation, lots and lots of tools that are surprising in a business that is relatively low volume compared to consumer products businesses. How do we get away with that? We get away with that because we source all of our global demand out of dedicated factories in one place. Finally, the other two important buckets are development activities. We look at our business opportunities to see if we think we can add value and if we're going to have a return on investment. I'll spare you a long conversation on pricing and multiples. By the way, the Corob deal, which I said kind of fits within our special sphere, was not as cheap as I'd like it to be, but it was between 11 and 12x. So we try to avoid those deals at the elevated levels we've seen in some markets over the last few years. And then shareholder return and returning money to shareholders. I don't think of Graco as a classic cyclical company, but because of the industries we serve — construction markets, automotive, semiconductor, farm, etc. — you, Wall Street, does. So what that means is, as a cyclical, once every three or four years we go on sale, right? 30-35% down. I know this because I've seen it over my time frame with the company. When that happens, we like to be in a position to move quickly and move aggressively. If you look at the long swath of our history, we track our purchases over the last 20 years. We've brought in a little bit more than $2 billion worth of stock; our return on investment on that is about 155%. If you look at when we bought — maybe we could have been more aggressive in '08-'09, but we were in the market in '15 when it was quite soft for industrial companies, some people have forgotten that. We were buying aggressively when COVID hit, and even a couple of years ago in 2022 when our stock was down nearly 30%, we were in the market. We always like to have the financial flexibility to do all of those things when the time is right. The drivers: number two, development, and number three, buying stock, does depend on what the price of the merchandise is.

All right, well it's a good question. I would say that our model — what helps us — is that we consolidate all of our volume in single locations. As you said, we are not a high volume business. What's a high volume business? If you're making power drills or something, you're measuring your output in the millions. In our contractor business, which would be a high volume business for us, we measure our output in the tens of thousands of units a year. In our industrial business, where I spent about 25 years, we measure our output of high volume units a few hundred a year. So you look at this and you're thinking, well gee, that's not a lot. But first thing, you can see it builds the case for doing it in one place. And while the volumes are not high for individual SKUs, we share lots and lots of common platforms, technologies, and parts. So we may have individual parts that go into dozens of different pumps, dozens of different spray guns and such, and we are able to build it on a cost-effective basis. Maybe we are lucky in the particular choice of the competitors that we have in our marketplaces. I talk about these niche markets; they are a few hundred million in revenue normally. A big one for us might be the pro-paint side of the contractor business — sorry for the jargon — maybe that's a billion dollars worldwide. That would be a big one for us. So in those spaces, there are companies that we compete with, including some public companies you're familiar with. We compete with IDEX in two or three places, great company. We compete with Nordson in a couple three places, great company. Dover and IR and such. But we really aren't competing with global behemoths. We're not in these five, ten, twenty billion dollar markets, and we don't find ourselves competing with Siemens or Emerson Electric or Honeywell or Rolls-Royce or people that could overwhelm us. We're competing with a handful of sophisticated corporate players that are competent competitors, and they compete in the right way, and they want to make money as we do. So far, it's been a recipe for success. And just to put a number on that, 8% of cost of goods sold is labor, so the labor component is quite small. Then you're really talking about the raw inputs, which there are global markets that we're buying those off of.

That's a hard one. Do you want to do it? Pros and cons. There are pros and cons. Obviously, from the company side, as opposed to your side, the quarterly reporting drill is an ongoing drumbeat. The annual reporting requirements, the filing of the 10-Ks and all that — it's an expensive process. How smaller companies do it, smaller than Graco, I have no idea. What I would say, as I think about your question, we do strive to take advantage of some aspects of being a public company. Employees around the world, except in places where it gets complicated by taxes and local law, but most of our employees are here in the US, so these things work. We have a couple of what I would call participation programs with our employees that they can take advantage of the financial success of the company over many years. Like a lot of companies, there's no great secret here. We have an employee stock purchase plan where you can buy in at a discount every year. Once a year, you get shares at an attractive price that as an employee you can retain, and we hope that most of them do, or you can sell right away. As a way of participating in the organization and making people owners, having skin in the game is part of it. We also have, maybe a little more unusually, a rather generous all-employees stock grant program. Typically on a three-year drumbeat, we grant stock options to all of our employees, as I said, except in places where it doesn't work or it's too clunky. But in the US, it works well here. Those stock options vest over time, and it's another way with leverage of giving employees some additional skin in the game. When we look at the heart of our business, it's our factories. We're an operating company, we're not a portfolio company. We probably aren't a classic industrial marketing company either. The heart of our business is our factories. In our factories, if you visit them, you will see they're warm in the winter and cool in the summer. There aren't a lot of sharp objects, there aren't pools of water lying around, it's not dusty, it's not noisy. When you go and start talking to our employees in the factory, you'll find not just machinists but assemblers and packers that have worked there for 20, 30, and 40 years. How's that? We pay a competitive wage, we have a suite of benefits, and we offer them a way of sharing in our success with these kinds of programs. I would argue it's that stability and the buy-in that the employees have for us that has contributed very substantially to our success over a long period of time. They can raise families in a metropolitan area, they can save money for college and for cabins. We do all of this — I hope not to offend anybody on the East Coast — these are non-union operations, and we're in Minnesota, for God's sakes. So I think it says something about the way we try to make our relationship with our employees. We have a shared set of objectives and interests, and in some small way, being a public company helps us.

Okay, so it's a timely question, right? And a good one. Of course, the answer is we don't know right now. We don't know how this is going to play out. As a manufacturer with most of our operations in the US, I would say the vast majority of our key vendors are domestic companies or located nearby. It's just the nature of how logistics work in manufacturing, except in some cases with some materials and some electronics that come in from overseas. So as we've tried to get our hands around that part of the equation, it's not nothing, but I'm talking about adding to our purchase cost one or two percent. That would highly surprise me. That's not really where I lose sleep. Where I do lose sleep is we don't have complete visibility, and I don't think anybody does, as to where do our vendors get all of their parts, where do our vendors do their buying and such. We probably have a degree of dependency there that we don't understand today. I'd be exaggerating if I said I'm not worried about it, but I don't know if that's a million or ten million. It's probably not multiples of that, but it could be something. But then lastly, the real question — and I know this is the Harvard Club, and I didn't go to Harvard — the complications, the risks, and maybe the opportunities of changing the relationship that global trade has been based on and has been developing during the whole post-war period. We don't know. It could represent an opportunity in terms of when countries look at these really niche products that are used to help make their countries and their markets more productive and meet the needs that you folks were talking about at the beginning of the presentation today: need for infrastructure, need for more housing, need for more water, need for more things. Maybe we'll get a pass, but there's no guarantee that we will, and we'll have to see.