Graco Inc (GGG) 2002 Q3 法說會逐字稿

Good morning. My name is April and I will be you're conference facilitator. At this time I would like to welcome everyone to the Graco third earnings conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star then the number one on you're telephone keypad. If you would like to withdraw you're question please press the pound key.

Our speakers today are Mr. Dave Roberts Chief Executive Officer and Mr. Vice President and Treasurer. Mr. Sheehan you may begin you're conference.

Thank you very much. Good morning welcome to our third quarter conference call. I'd like to start today by mentioning that any forward looking statements given in the call about the company's expectation of the future are subject to certain risks factors that could cause our actual results to differ materially from those expectations.

these factors are identified in exhibit 99, to Gracos annual report on form 10K for the fiscal year 2001. Please refer to our form 10K to review those risk factors.

First I'll quickly cover some highlights of the quarterly results and then we'll open up the lines to your questions.

Overall we are pleased to report that our sales increased this quarter. You might recall that three months ago we reported a one percent increase in our second quarter net sales and today we reported that third quarter net sales had risen by six percent versus the third quarter of last year.

For the year our net sales are two percent higher than last year. Our two largest segments, the contract equipment and industrial automotive equipment segments reported net sales increases of seven and eight percent respectively this quarter, and our lubrication segment sales were down eight percent. We're also pleased that we could report a 22 percent increase in net earnings this quarter and a 20 percent increase in net earnings for the first nine months.

Improved profitability was evident through out the income statement led by higher gross profit margins and higher operating profit margins both for the third quarter and on a year to date basis.

Exchange rates which have hurt our net sales and earnings in the past actually helped our sales and net earnings this quarter. It's estimated that favorable exchange rates contributed about two cents to these quarters diluted earnings per share.

Turning to the segments, the first starting our with industrial automotive. There sales were up eight percent for the quarter and one of them up five percent with consistent exchange rates. The reported net sales were higher than last year in all geographies. The division experience in increase in quarterly net sales resulting from a number of factors including favorable exchange rates, higher automotive business and a slight increase in the base business.

Profitability remains strong in this division, in fact for the first nine months on an overall one percent increase in net sales, the division is reported at 16 percent increase in operating profit versus the same period last year.

We're not yet prepared to say that the recovery is at hand for this business. Much of the growth in the quarter is attributable to favorable exchange rates in Europe. Increased automotive business in the US, particularly from Foreign manufacturers who are building capacity here. In addition the economic outlook is still cautious as the forecast for 2003 in most major regions like the United States, Europe and Japan are somewhat weak.

Turning next to the contractor business, there sales were up seven percent for the third quarter and four percent year to date and the third quarter North American sales were higher both in the home center and the professional paint channels. Sales this quarter were also higher in Europe and the Asian pacific regions.

This business has also done a nice job in improving its profitability this year. Year to date profits are up 18 percent of a four- percent net sales increase. As we mentioned in the release this business continues to benefit from new product introductions as well as strong hand market as evidence by today's record housing numbers.

In the lubrication equipment segment our sales declined eight percent in the third quarter and they're down five- percent year to date. Year to date profits are down 16 percent verses last year primarily due to the lower sales as well as some planned incremental spending in product development.

Looking at gross profits the gross profit margin improved again this quarter. Gross profit margin for the third quarter was 52 percent compares to 49.9 percent during the third quarter of last year.

The year to date gross margin of 51.2 percent is higher then the 49.7 percent gross margin recorded for the first nine months of last year. Gross margins are better for several reasons including price increases, favorable exchange rates mentioned previously and manufacturing cost improvement activities.

You look at operating expenses over all they were slightly higher in the quarter verses last year's third quarter. From last year's third quarter included approximately $1.9 million of restructuring and other related charges. The increase in operating expenses was primarily driven by higher sales incentives, increased product development spending as well as higher general demonstrative spending for incentives and other miscellaneous items.

The tax rate for the quarter was 32.3 percent and that's also our year to date effective tax rate. This is the same effective tax rate that was recorded for the first six months of the year.

A couple of cash flow items. Cash flow from operations was approximately $34 million for the third quarter and is that $73 million year to date. Depreciation and amortization was approximately 4.5 million for the quarter and $14 million year to date.

was approximately three million for the quarter and seven million-year to date. Cash dividends paid in the third quarter was approximately 3.5 million and then 10.5 million year to date.

The backlog at the end of the quarter stood at $17 million verses 12 million at the end of last year.

Includes my introductory comments and I'll ask April to open up your lines for any questions that you'll have.

At this time I would like to remind everyone in order to ask a question, simply press star then the number one on your telephone key pad.

Your question has been asked and answered you may remove your signal by pressing the pound sign.

We'll pause for just a moment to compile the Q & A law forum.

Our first question comes from Mike of Robert W. Baird.

Good morning Mark.

Hi Mike.

Good morning Mike.

: Good morning Dave just some questions I guess.

Mark I'm curious about your comment in the industrial automotive. Obviously things are benefiting there from the Euro but base business is up as well against some easy comparisons.

You said higher automotive sales especially in the U.S. by some of the Japanese transplants. But yet a slight increase in the base business. I'm wondering what you meant by that latter comment?

Well basically the automotive business is related to some capacity expansion.

: Yes.

Well basically the automotive business is related to some capacity expansion here in North America. And so from a, you know, recurring standpoint those jobs come and go, and it's difficult for us to project whether or not we're going to see continued growth of those types of jobs. So if you factor that out of the growth equation and you just look at the base business growth, and , it was a pretty modest pick-up.

: OK.

And I guess I'm curious on your thoughts on that segment now. Obviously that is the one you're going to see the biggest impact on. And even just yesterday in the "Wall Street Journal" front page article about how businesses are learning to get by, or striving to get by on less and in particular less capital investment which speaks right to your industrial automotive segment.

Give me your thoughts just upon reading that article, and give me your thoughts as to what you're hearing from your customers. In particular was cited in the article as spending $1 billion less in capital investment as it kind of perfected a model where they can get by with less capacity and less equipment. Which again speaks to your industrial automotive segment.

Mike if you'd look at our industrial automotive segment, the sales that we had this past quarter were really to non-U.S. manufacturers. If you back up and look at our business as a whole, 50 percent of the business that we sell into automotive is our parts business.

: Yep.

So we've got a sustained business stream or revenue stream that comes from that business as they continue to repair their equipment, you know, for parts accessories - with parts accessories and so on.

Where we're really seeing a nice increase in equipment orders is coming out of Asia, and you know, primarily China. In that - in the numbers this quarter there were three very large orders that were received to support expansion of the Japanese automotive manufacturing industry as well as joint ventures into China. And that's where we saw the increase.

: OK. And I guess the sustainability of those trends, is that where the increase in backlog has come as well in that segment?

You know I would say that our outlook is pretty much in line with what you said the paper said yesterday. We're cautious about it. We like the fact that sales rose. Some of it was currency, some of it was these, you know, these orders that we got in automotive. And you know, we'll take them anyway we can get them.

But when we look at the forecasts for next year, in the big places like Europe and Japan and here the numbers support more the conclusion that you said from the article yesterday. So we'll take what we can get, we like the results but we're still pretty cautious in our outlook for the business.

I think we probably sound like a broken record, but we're cautiously optimistic about out industrial business. You know, we still see some activity out there. That activity isn't turning into orders. But at least people are looking at new equipment.

: And you've got a fairly healthy pipeline of new products in that segment. So if we assume a flat market from here, steady as she goes into 2003, with the new products what are you modeling into or hoping for in terms of top line organic growth in that segment, based on this new product flow and surprising increases, presumably?

Well I mean, I think that, you know as we've met with a number of analysts, floor managers and so on. We've stated that we can have organic growth in the area of maybe four to six percent. That really comes from each of the divisions you know certainly being the vast majority of our contractor business. Industrial being in the middle and lubrication following.

And that's even in the market assumed to be kind of status from here. I think that would assume some underlying growth you know type growth.

: OK. And then I guess margins and industrial automotive another near record number - just a phenomenal job on you part and you should be congratulated many times. What should we assume about the sustainability of that. Four cores are obviously benefiting it.

Right. Certainly we can't control currency as you know . There are a number of efforts that are under way and manufacturing to continue to improve the operations. Along with that new products generally bring higher margins and we still think there's room for margin improvement going forward but it's difficult to predict what that will be.

: OK. I'll get back in line. Thanks guys.

Thanks Mike.

OK gentlemen. Now our next question comes from of

Good morning guys.

Hey .

Hey John.

: Your lubrication segment has been anything but smooth selling in the revenue side.

Right.

: Down some 10 13 then 10 again. could you provide a little color on what's going on there and why the inconsistency in the ...

What's really happening in that division John is if you take out the one very large order we had last year was with . The business is relatively flat. Now you know it's a flat to declining market place. We think we've done a nice job in being able to grow the business through a competitive product offering. Frankly other than the large order we're out fighting for orders every day. We got the large orders last year that we got we're out fighting for orders everyday and it's a mature difficult market place.

: But Dave that's down sequentially from the second quarter about 24 percent. I mean in the current year. Q3 versus Q2.

I think a lot of the incremental business and I'd have to go back to confirm this John but I think that a lot of the incremental business that we got last year was during that time frame that we're taking about and I think our comments would be that if you were to adjust for that which we going in to the year really were of that mind set that we weren't going to get that business again. This is a business that is really coming in on the top line about where you'd expect a business to participates and a mature market to be to be flat.

: OK. . You touched on price increases you able to sustain that? Could you elaborate a little with product lines and what in markets are you going to hold the price increases.

It really varies. We don't do across the board price increase. Primarily we look at you know different products, price segments and then adjust price accordingly. Where we're able to deliver the largest amount of price increases generally out of new products.

: That would be updated products or brand new products because how would you have a price on brand new products?

I mean if you look at what we call an updated product really there's additional feature it's not just a new color there's additional feature that would - you would project that you would get a price increase from that.

: Now on the side of the business you to the fact that most of new workers coming from foreign transplants I ...

How far are you able to slice you business there. How much do you know goes to domestic versus foreign.

Well we certainly know the large orders that come in and we know that the third quarter were all a lot of the foreign transplants.

: Could you give me a sense of the mix of percentage of this goes to what.

You know I don't have that number. We would have to go back and look at it but I can tell you the big projects were all foreign.

: Were all foreign.

Yes.

: You seem to kind of hedge a little bit about your out look on that side of business. I know that did a little bit too yesterday so your general article but the CFO from ford is not going to be cutting cut backs for 2003. Is this a is this a market that probably has bottomed and we'll probably see a recovery next year. Is that your sense.

Yes I think if you look at our industrial business over a two and a half year basis a year and a half basis since let's say mid year 2000. It tailed off at about 12 percent and it's been relatively flat since then and you know we're frankly we think that could be the pattern going forward.

: Ok great one last question cause nobody seemed to ask is cash continues to build up at a rapid pace. How is the acquisition market out there, which a sense of what're you going to do with it.

Yes we we averagely we don't plan it on any activity that we've either been involved in or we're involved in or gonna be involved in. But I mean if on a zero basis we're finding that there aren't a lot of people out there trying to pedal a business.

The businesses that we've seen are businesses that you probably wouldn't want to be involved in and but we're still aggressively looking. So that's about all we can say about acquisition.

: David at some point do you feel that it you know having as much cash in the books becomes prohibited.

I don't know.

It becomes prohibited but I think we've got to we'll certainly monitor it. We've got $93 million today. That's up from where we were obviously second quarter first quarter and you know if we can't find a good acquisition here you know and I don't know if it's six months or a year we're going to have to do something with the cash.

: Ok thanks a lot. Bye.

Somehow our next question comes from of Credit Suisse First Boston.

Morning Dave morning

Morning .

Nice quarter.

Thank you.

As far as looking at the geographic breakout here in you Press Release you commented on US is up four percent and it's currency. Europe is actually down on low currency five percent. Pacific up 25 percent. Can you give a little color on that and then any efforts you got as far as distribution and channel expansion there.

Well let me talk first of all about channel expansion. We and I think we mentioned this on the last our last conference call. We added a new to continue to grow the number of distributors we have servicing our market place in China.

And frankly we've seen some improvement just because of the opening of that warehouse. If you look at our industrial business the vast majority of the growth percentage wise came from Asia and primarily China.

If you look at the CEE business it's we've had some nice growth in Asia and frankly we've had real good growth during the last month and a half in Asia in our CEE business.

And we think that's all related to the addition of the warehouse that we had recently in Shanghai. We'll continue to invest in those areas, we still think that the Chinese market as our customers are moving there. We'll continue to focus there and we're doing some things next year to spur sales on our contractors side of the business.

Right. And then on the European side what's turning the five- percent drop there.

Well you know as you look at the market place Germany frankly as a concern we recently have been following France and France is starting to take a downward turn and frankly we're very cautious about what's going on in Europe. The German market, I think the last numbers that I saw they were forecasting their to be maybe 2.2 or 2.3 percent. That's been recently adjusted down to I think the numbers are 1.5 percent so we're very cautious and in Germany obviously is our largest market place there.

Right right then moving on to any other progress to report on homes center distribution channels.

Well other than we continue to work it you know we haven't given up but it certainly is a priority of ours but you know nothing to announce at this point.

OK great. The gross margins, nice improvement, 210 basis points there attributing to price affixing costs is there a little ball part break out that you can provide there between the three components.

They're listed in order of they're importance but in terms of giving you percentages I wouldn't feel good about doing that.

OK fair enough. And then on the lubrication division here, you mentioned in your comments that your product and development spending is increasing there. Any insight you could provide there as to the potential outcome of that.

Yeah in fact we are in the process of introducing a brand new product there that's called , that we think will be a nice plus for us next year from a revenue side going in it also potentially gives us a product that we can sell outside of North America.

How's that.

Well it's a product that offers additional feature that will be of value to the European market place and we think the Asian market place.

OK and then just a couple of quick numbers thing here I missed you said three million for the quarter.

Let me get it again here.

Sorry about that.

I want to make sure ...

I got three and three five for and depreciation amortization.

Yeah well it was seven million for the year and ... is digging it out now.

was three million for the quarter and seven for the year.

OK and then depreciation.

D&A?

Yeah.

D&A was 4.5 for the quarter and 14-year to date.

OK great and then for the year we're still shooting for 13 on and then the same for '03 is the outlook.

It might be a little higher on the or we're not holding anything back it's just a matter of when we get the projects approved and cut the .

So some of the '02 may spill into '03.

Yeah.

OK and we're still targeting about a 13 million for '03.

Yeah.

OK great. All right thanks I'll go back in line.

OK thanks.

Gentlemen our next question comes from of .

Hi good morning ...

Hi Jim.

Did you just tested out the industrial and automotive I mean was any in the industrial business or did it all come from the automotive in the quarter.

Well we don't break them up that way Jim we really report them as a combined segment so we don't have data that would split those out the industrial business in general is a as I said on a reported basis was really up in all geographies - Europe obviously the Euro currency was the driver behind that but in terms of the industrial automotive business the actual increases were higher in all the geographies.

OK. And then I guess if we looked into 2003 in this segment industrial automotive because the new plans that kind of of those projects aren't certain. But going into '03 you have to benefit the Euro and as well as some modest growth in the base business. Is that correct?

Yes.

OK. And could you just kind of talk about a your exposure to the new housing market. You know I guess the concern is just at somewhat that new housing market will peak?

Yes Jim

Are still trying to figure out.

Doing that but I don't know if you saw the latest new housing market numbers that came out. It's a million eight four the highest number since 1978 it was a 13.3 percent increase over the previous numbers is the highest since 1995.

We obviously we watched this number very closely because it really drives our contractor business. You know we continue to read that it's got a peak at sometime and it's going to decline. But as long as this market is you know a million four or you know a million 350, it's still a healthy market for us.

So there's - it's got to decline significantly to really have a major impact on our business. Our contractor business.

I guess from your history what I guess what level do you start doing the painting of our slower housing market. I mean

I don't know that we'd really want to put a number on it and the other thing that you got to keep in mind is it's not owning activity then we have a better position to take advantage of that now because of our home center presence and then you've also got repaint activity as new homes go on board you know we've had, we've had a number of years now with very strong housing certs as those you know get older the likelihood of additional repaint goes up and so there's a combination of activities that really help to drive that business and you know we are in a pretty good position to benefit from all of that economic activity through that - the business.

OK. And then you want to comment on your new products for 2003 if you have anything that you're launching in '03 that.

We've got, we've got a brand new product in our industrial segment that in fact we're launching this week in the U.S. We've got ourselves force inner being trained on it. It's a protective coating product.

We launched it two - three weeks ago in China or Asia and you know it's a product that we think will have nice up sight for us on the industrial - in the industrial market place.

We generally have new product introductions on our contract in our contractor business at the start of the year that's a pattern that we generally follow is about what I can tell you on the contractor's side and we've got some other products that we're investing in as we said in industrial as well as lubrication.

But there's really no - there's no there are no dates that we like to give out at this point other then we generally follow a pattern of you know start of the year product introduction for CED for contracts.

These are pretty consistent with looking history potential, the number of launches and the potential of all these products have?

Yes I would say that's generally true you know we tend not to make comments about all three products.

Right.

Specifically just for competitive reasons.

OK. And then just one last question Dave. You talk about growth - organic growth rate earlier of about 4 I think 45 - 46 percent?

Right.

Are you referring that to '03 or is it more of a kind of ...

Well it's looking over a you know what we call our planning horizon which is five years.

OK.

I think over a five-year period organically we can grow the business four to six percent.

OK and if you were to look at '03 what kind of organic growth do you think you might do?

You're asking to give projections and we just don't do that.

All right I thank you .

OK.

Gentlemen our next question is a follow up question from Mr. Mike Snider of Robert W Beard.

Could you talk about the selling initiative that you mentioned Mark you mentioned that closer up on the GNA line because there's some higher sales incentive maybe ...

Yeah Mike it's really related to the fact that we're doing a pretty good job this year and so our sales organization is in terms of what we pay them in incentives we .

Oh I see so it's not some new initiative where you.

No, no.

You've increased the selling commission.

No, no.

OK so these are your bonus as they achieve there higher. In your I apologize you said GNA was up for two other reasons. What were they again?

Well GNA is up in addition for some you know small spending in things like information systems.

Yes.

And also incentives in the GNA line.

OK and then secondly on the CED segment. Are you still benefiting from this Gene X roll out in the second half here?

Well now we've actually got a new product Mike that's been introduced that's called the GH200.

Right.

But there's that came out I think it was six weeks ago. We're actually ahead of forecast on that product offering.

OK all right. That makes and then also the promotional efforts you've had under the way for the magnum DX line.

Yeah we had in fact if you had looked at our numbers the last quarter our home center numbers were driven by that promotion that DX promotion you know home depot had or had significant advertising that went on late in the summer for it and we saw some real benefit from that from a sales stand point.

OK so that promotion is ended now.

Yes.

OK and finally just guidance for the fourth quarter. Do you care to share any with us you didn't have any in the release?

No.

We don't provide guidance Mike.

OK thank you.

All right.

Gentlemen now our next question is a question from Eric End of First Pacific Advisors.

Hi great quarter.

Thank you.

Hi Eric.

Could you give us an update on the consolidation?

Sure that was completed in July of this year. We are now completely out of the operation and we have the manufacturing activities underway here in Minneapolis.

Is that going well in Minneapolis?

Yes.

OK on another topic. I had, had a reporter a few months ago from an analysts that there had been a change in payment terms at home depot. Is your understanding of that happened? Did it apply to you?

Yes it did. It was at the start of the year. Payment terms changed and you know we're complying and they're complying with there new terms.

OK was that an adverse change?

Yes.

Yes it was. They extended terms.

OK that's it. Thank you.

OK gentlemen at this time I would like to take a moment to remind all our participants that if they would like to ask a question just simply press star then the number one. While we're waiting on the others to queue up we have a follow up question from .

Guys we don't really talk much about the competition. Could you give me a sense of what the competitive environment is in the adhesive or sealant market.

Well you know, really John I think the competitive landscape is basically the same in all of our markets. You know people are feeling the pressures of a slow down in the economy and we are seeing competitive pressures in all arenas. It would be difficult to sort it our by adhesives or finishing or shortages, its just highly competitive.

: Do you get a sense that some markets are more competitive and that you hold a better position in others.

Well you know, I think we have intelligent competitors. I think people recognize that the market place is only going to allow for so much capital sales, and I think we certainly compete in those market places. But I don't see anything that would cause us concern from people getting overly aggressive in pricing, or price reductions.

: OK, just a thought thanks.

Same.

Gentlemen, our next question is from which is a follow up question from the office of .

: Sorry, just a quick one, tax rates going forward to change geography any guides we provide on that? Should we assume its going to be the same or change one way or the other?

I think it should be pretty much the same period.

: OK, great and then Dave earlier mentioning the parts business is a pretty stable business to have.

Yes.

: Do we have a breakout we have provided by each year's segments as to what percent revenues those represent.

We don't , we can tell you though that 40 percent or approximately 40 percent of our revenue is generated by parts and accessories, in total.

: OK.

Ok.

: Right thanks a lot guys.

All right.

Gentlemen at this time I show that there are no further questions.

OK, great well thank you all for participating. I guess at this point we will end the call. Goodbye.

Goodbye.

Thank you everyone for participating in today's conference you may now disconnect.