Graco Inc (GGG) 2004 Q1 法說會逐字稿

Good morning and welcome to the first-quarter 2004 earnings conference call for Graco, Inc. If you wish to access the replay for this call, you may do so by dialing 1-800-642-1687 within the United States or Canada. The dial in number for international callers is 706-645-9291. The conference ID number is 644-8485. The replay will be available through April 19th, 2004. At the request of the Company, we will open the conference up for questions and answers after the presentation.

During the call, various remarks may be made by management about their expectations, plans, and prospects for the future. These remarks constitute forward-looking statements for the purposes of the Safe Harbor provision 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 Exhibit 99 to the Company's 2003 annual report on Form 10k and its most recent 10-Q.

I will now turn the conference over to Mr. Mark Sheahan, Vice President and Treasurer.

Good morning and welcome to everyone. Dave Roberts and I are here this morning to talk about the first quarter results and to take your questions. I'll start out just by reviewing some of the highlights of yesterday's press release.

Overall, we're pleased report another net sales increased this quarter; the 13 percent increase in sales represents our eighth consecutive quarter of revenue growth. It was also our third consecutive quarter where all three of our divisions reported higher sales when compared to the same periods in the prior year.

The revenue growth in the first quarter of 2004 was driven by nice growth in our Industrial/Automotive business where sales were up 21 percent; growth in our Contractor Equipment Division, whose sales were up 8 percent, and then geographically we had growth in Asia Pacific of 28 percent and growth in Europe of 18 percent. Once again, favorable currencies added to the quarterly results when compared to a year ago. Translation rates added about 4 percentage points of revenue growth and about 13 percentage points of net earnings growth for the quarter. Once again the weaker U.S. dollar versus the euro was the primary driver for this favorable currency impact and it's similar to what we've been experiencing for several quarters now.

In the first quarter of 2004, the average euro to dollar exchange rate was about $1.25, and that compares to about $1.07 in the first quarter of last year. For about a 17 percent weakening of the U.S. dollar on a comparison basis.

For reference purposes, our average euro currency rate in the second quarter of last year was $1.14. So if currency rates remain at their current level, we won't experience as much benefit in the second quarter as we did here in the first-quarter.

For the first quarter of '04 our EPS was up 28 percent and that reflects the combined impact of the 23 percent increase in net earnings as well as the reduction in shares outstanding from share repurchases.

Next I'll touch briefly on our three segments and how they performed in the quarter. Starting with our Industrial/Automotive group, sales were $63.3 million in the first quarter which is a 21 percent increase from last year's first-quarter. If you were to take out the currency impact in the Industrial/Automotive sales, their revenue would have been up 14 percent. Also if you were to take out the currency in the Sharpe acquisition which was completed last year at the end of March, Industrial/Automotive sales were up 10 percent. This business experienced volume growth in all regions.

In the Americas, their sales were up 21 percent, and the quarter was really characterized by strong incoming orders throughout the entire quarter in all of the major product categories.

In Europe, Industrial/Automotive equipment volume increased four percent and the reported sales were 19 percent higher after adjusting for the euro currency.

In Asia Pacific, sales remain strong. They were up 23 percent; they were up 20 percent when measured at constant exchange rates.

We saw a nice pickup in profitability for Industrial/Automotive in the quarter. Operating margins came in 32.8 percent which compares to 26.7 percent last year. Operating profit dollars in this business grew 48 percent versus last year's first-quarter.

To summarize, Industrial/Automotive equipment division results, we continue to see underlying growth in the Americans; sales were up 21 percent from last year's first-quarter. Underlying demand in Europe has improved but we're not yet certain about the direction for the remainder of the year as most of the forecasts indicate little projected underlying growth for 2004.

The underlying growth in Asia continues to be strong, we're experiencing the demand for our products throughout the entire region and we're also pleased to see growth in Japan this quarter.

Next, taking a look at our Contractor Equipment division, when compared to last year's first-quarter worldwide sales of $59 million increased by 8 percent. In the Americas, sales were up four percent and we experienced growth in both the home center channel as well as the professional paint store channel.

Asia-Pacific sales for contractor were up strong, with increases in all of the product categories throughout most of the regions with the exception of Japan. Europe was also up 18 percent which resulted from underlying growth of about three percent and the rest coming from the currencies.

In contractor, the operating profit margin for the first quarter was 20.4 percent; that compares favorably to 19.6 percent last year, and operating profit dollars grew by 12 percent in this business versus last year's first quarter.

To summarize a Contractor business, the sales were higher in both the home center and paint store channels and the Americas. We are seeing good demand for some of our larger units in the paint store side of the channel, the Ultra Max and the GMAX products in particular as well as some of our striping and texture equipment.

Europe is banning from a combination of modest underlying growth and a strong euro, and Asia is continuing to grow as we build our market position in that region.

Lastly, looking at the Lubrication Equipment business, their sales were 12.8 million for the quarter which is up about three percent from last year. This increase came mostly from the Americas and the Asia-Pacific region. Operating margins were 23.5 percent which was similar to what we reported in the first quarter of last year.

Looking next at the Company's grossed profit margin for the quarter, Graco's gross profit margin was 54.4 percent, that compares to 52.7 percent for the same period last year. The favorable comparison here is driven by exchange rates as well as product and manufacturing cost improvements that were made in our factories.

You will recall that the exchange impact on gross margin is favorable for Graco since changes in exchange rates have less of an impact on cost than on sales. Since about 25 percent of our sales are in non-U.S. dollars, only 5 percent of our cost of goods sold are in non-U.S. dollars.

Reviewing the operating expenses for the quarter, our operating expenses as expressed as a percentage of sales were 29.6 percent in the first quarter, and that compares to 30 percent in the same period last year. Spending was higher in all three categories but was in line with the sales increase. Some of the items contributing to the higher spending included the unfavorable impact from exchange rate changes on foreign-based expenses; higher product development spending; a $1 million contribution to the Graco Foundation in the first quarter of 2004, versus no such contribution in the first quarter of 2003; some planned demolition costs associated with a factory closing here in Minneapolis; and higher incentive accruals associated with our improved financial results versus last year's first quarter.

The tax rate for the quarter was 33 percent which is similar to last year's full year rate of 32.2 percent. Some other items worth noting in 2004, our cash flow from operations were strong, $27.9 million versus 17.5 million last year. Significant uses of cash so far this year have been dividends of $111 million, which include a $104 million special dividend that we paid on March 25th; share repurchases of $15 million; and planned property and equipment additions of about $5 million.

Accounts receivable are higher than a year ago, really reflecting the increase in sales. The impact of currency in the Sharpe acquisition and inventories are higher than a year ago as well, really from the increase in revenue.

In summary, Graco had a good first quarter with a 13 percent increase in sales, a 23 percent increase in net earnings and a 28 percent increase in EPS. As in the last quarter, we believe we are in the midst of a recovery for our Industrial/Automotive business in the Americas. We now have two strong quarters to prove that. In Asia-Pacific our sales remain very strong as infrastructure investments are prevalent throughout this region. And our sales in Europe were actually slightly higher than anticipated with some underlying growth this quarter and the favorable currency environment continues with us or continued with us in the first quarter.

That concludes our prepared remarks. Let's open up the call for your questions.

(OPERATOR INSTRUCTIONS) Michael Schneider with Robert W. Baird.

Good morning guys. Congratulations. Very nice quarter. I think we can start with the industrial group, obviously the recovery is underway. Can you give us any further details on what markets in the U.S. specifically are acting best for you?

Yes. Mike, what I can say about the U.S. is that frankly we are seeing great reaction or great activity in all the markets, there is not one individual market that's much stronger than the others, and even better as we looked across our four market segments that we cover, our product segments, all four of those also have been strong during the last two quarters. I think that the good news is that the economy is recovering as well as I think the work that Chuck Rescorla started a couple years ago with specializing the sales force and continued by Fred Sutter (ph) has really started to pay off for us. So I think it is really a combination of the economy getting stronger and our sales focus actually is much stronger as well.

When you look across your customer base, it isn't just being driven by wood finishing, or marine or automotive or anything -- it is truly broad-based?

It really is, Mike. And even if I look not only in North American but around the world, I think that is the case. We've seen some nice activity come out of Vietnam for wood furnishing this year. That's up about double what it was last year so far. We've had a couple of nice automotive jobs come out of Japan. But still none of those are large enough that would lead us to believe that the activity we're seeing is just a result of one or two major orders.

And in Asia specifically, is the growth still being primarily driven by the automotive builds over there?

No, actually, as I said just a few seconds ago, we're actually seeing some nice growth coming in just general industrial markets. I was talking about the wood manufacturing plants in Vietnam; we booked already this year equal to what we sold the entire year last year in that region. China still continues to be strong; frankly our strongest country again this quarter was China along with great growth coming out of Japan for the first time. There is nothing to indicate that is primarily just automotive, frankly its across all segments of the industrial marketplace.

Just generally speaking, and I don't know if you want to handle price by segment or just broadly speaking, but how much this year have you put in place in terms of price increases? And maybe you can break, Mark, the growth price versus units -- that would be great?

Mike, I think that I will just talk generally. We typically don't talk specifics about prices by segment. The pricing increases for the year have been very modest. We did have price increases targeted at some of our units; we had price reductions in some of our units as well. The overall effective increase is maybe 1 percent, 1.5 percent.

Final question and I will get back in line. Just in terms of capacity, you really just have the two manufacturing centers. Where are you today and at what point do you need to start adding bricks and mortar?

We took a real hard look at that here just at the end of last year. If you look at square footage, we're pretty close to capacity in square footage but our business really isn't a square footage issue from a volume standpoint or capacity standpoint. It's really machine hours, and we think were probably at 75 to 76 percent capacity utilization in our machining centers. We still have some room to grow without adding any plant capacity.

Are you working overtime today generally speaking?

We do a little bit but only on an as needed basis. There's really nothing out there that we're running six or seven days a week. Unless there happens to be a shortage pop up or something that would be within the norm of a manufacturing operation. But, no, we're not working heavy overtime in any area.

So are you at the point though where you're on the cusp of adding a half a shift or something like that rather than just incrementally adding people to the first shift?

You know, actually no. I think we will probably add a few people to one shift or another, but there's nothing that indicates that we have to go to a -- as you say either a half shift on the second shift or a full shift on any of the third shift. We have no indications of that yet.

Great, I'll get back in line. Thanks.

John Franzreb with Sidoti & Co.

My first question is on the gross margin. In the press release you site the year-to-year growth which is largely due to the currency. But as I recall the Industrial Automotive segment tended to have higher gross margins than the contractor and that businesses is up now year-over-year. Could you kind of reconcile the two? I would think you would have maybe some impact coming from having a higher unit volume year-over-year on the I-A side of the business?

Well, one thing to remember is that the Industrial/Automotive business is really our global business. When we talk about currency impact in the business unit that it impacts the most, it would be our Industrial/Automotive business. When you look at the gross profit margin for the quarter for the company, compared to last year's and you try to reconcile the differences and just look at the currency, it is by far the vast majority of the change is coming from the favorable impact of the euro versus U.S. dollar. Currency.

How much of it would be the change in a mix, though, have higher I-A unit volume?

Again the currency piece of it is the majority of it and most of that currency piece is coming from Industrial Automotive so there will be some mix in there. To be honest with you, I don't think we've crunched the numbers that way.

Secondly, it seems like the contractor business should be more aggressive in growing that business overseas. I wonder if you can give us more color on what your plans are as far as growing that business abroad and how much of contractor is foreign revenues and where you see that say a year from now?

John, I don't have a breakdown in from of me of what we are doing outside of North America in contractor. But I can tell you that we've been very aggressive not only in Asia but also in Europe. In fact, our European operation added a small home center chain in the latter part of last year in France which has helped us. Our people down in Australia added the second largest paint store chain in that area; that's certainly has helped us. And we're working very hard to create the market in Asia itself, when I say Asia, primarily China. We've got a number of activities planned over the next three months that will help us create it and we think that is definitely the largest untapped market for us going forward.

I can't really give you an idea of timing because we're really a slave to how fast the contractors there will change to spray equipment, but frankly we're more optimistic today than we were probably twelve months ago that that will start to happen.

One last question. Could you kind of just discuss where our material cost and how that is impacting you? Are you being forced to absorb more? Could you give us a little bit of discussion with what's going on with steel prices, or anything else that may -- aluminum or whatever?

Certainly we are seeing the same steel price increases that everyone is. And primarily in our business, it is stainless-steel and the nickel that goes into stainless. We are absorbing those costs. We haven't seen a need for it to pass it along to our customer base yet. Frankly, the reason we're doing that is we think it's a short-term problem rather than a longer-term problem and we have absorbed those. Honestly the manufacturing area has done a wonderful job in being able to offset that cost increase with productivity improvement.

Like I said, I think the material cost issue is going to be a short term where we probably see some relief of that toward the end of this year.

Do you think some of your competitors are increasing prices in order to support those costs and you are finding yourself in maybe a competitive advantage that you can absorb them better them better than they can?

John, I think that could be the case. I can't really speak to it. But I think that we have certainly a proven history of being very active when it comes to productivity improvement and cost efficiency improvement. I would just have to say that you've got to assume that the competitors are doing the same. All I can tell you is that we've done a nice job in being able to compensate for the material increase.

Thanks a lot guys.

Charles Brady with Hibernian Southcoast Capital.

Thanks. Could you just give the FX effects on Contractor and Lube?

I'm sorry, I didn't hear the question.

Foreign exchange effect for contractor and lube.

On the revenues, I can. I can't do it by all the way down the P&L. But if you were to look at the revenue line on the contractor business, it was about three percentage points; and on the lube business it was about two percentage points.

Okay and could you just give us an update on what's going on with Matrix?

We're really in the final stages of evaluating the fixes that we've put in place. We're being overly cautious, to be very honest. I would anticipate that that unit will be reintroduced probably sometime early third quarter of this year. But we think we've got very solid fixes for the issues we had there.

Is there any commentary or (indiscernible) coming out of customers as far as when this thing gets re-rolled out what the acceptance will be?

The only thing I can tell you is that we had great acceptance when it was introduced; we haven't seen a competitive product out there that would suggest that the placements that we were thinking about or the potential customers that we were considering have gone to competitive units. So I think that if you look at the activity in the first quarter of last year perhaps, you would have to assume there was some ramp up in that and inventory being built at our distributors but we had great acceptance considering the size of that business in the first quarter of last year. I would hope that we would see similar activity once we introduce the new product. Now, when we do introduce the new product, we are going out -- we have I guess it's about 40 installations today that we're going to go out and replace those installations with the new products so the third quarter we would really be involved in replacing those existing installations and then you will see new customers being I guess nurtured during the third quarter with hopefully placements in the fourth quarter and in the first quarter in L5.

Okay. Could you give us an update on the warehouse automation system that went in this quarter?

It is being installed; in fact, we go to our first live trial on Monday. We spent a lot of time up front with the software writers, and frankly we think we've got a system that when it's turned on is going to be less trouble-free than had we not taken the time to go through the prove up in their location.

I can't really tell you anything until, like I said, it turns on Monday and we get a chance to start running through some live trials and really see what is going to happen there. Frankly we seen nothing that would indicate that it's not going to give us the productivity improvement that we anticipated when we bought the unit.

And has that been fully expensed?

It's a combination of capital and expense. Some of the -- obviously all of the equipment is capitalized; the software, there's a portion of it that was expensed and a portion that was capitalized.

Have you broken out the cost?

Mark, I don't have that. Do you have that information at hand?

We have not broken those out.

My final question and I will get back in queue. On the acquisition landscape, can you just give us what you're seeing out there opportunity-wise? And pricing, I imagine pricing might have gotten a little bit tougher for buyers.

Honestly, I think activity has improved, and when I say that I think there are more things that are coming up now that we're having a chance to look. Frankly, it hasn't been that active yet that we can really evaluate what's happening with pricing. But my anticipation is the same as yours, it that is going to end up increasing to the potential values you're going to have to pay for businesses.

But overall you see -- how far are you in discussions with people? Do you -- how close on the radar screen argue in terms of looking at acquisitions whether small, whether large?

We honestly just don't talk about acquisitions until we announce that we have a deal is about all I can say.

Fair enough. I will get back into queue.

Ned Armstrong with Friedman, Billings, Ramsey.

Good morning. Can you talk a little bit about the new product alliance with 3M and what type of progress you are seeing in the early stages?

In fact we're very excited about that product. If you pick up the latest 3M annual report, there's a full-page picture of the Graco spray gun along with the P.P.S. system that 3M has developed. In has just been rolled out, they rolled it out to two regions in the U.S. They're going to basically test market the roll out plan, the marketing plans and so on with the idea that they scan it to the rest of the U.S. by the end of this year. And then following that, as we understand they want to take it internationally.

So we are -- I don't have any numbers to give you yet primarily because we just made our first deliveries. But frankly I think both companies are very optimistic about what that potentially can do for as in the auto refinish marketplace.

Which regions are they being rolled out in initially?

Ned, I honestly don't know that answer off hand. I think there are in the South East, but I'm not quite sure.

Okay. With regard to Europe, you showed some real growth there, 3 percent after currency allowances. Do you --are you inferring a turn in that market based on that growth or is that still a little bit too early?

I think it's still too early. Still the largest economy in Europe is really suffering and that's Germany. We have not seen any indication that that economy has started to turn and frankly most of Northern Europe is still extremely soft. We are seeing much improved activity down through the Southern European areas; down into the Middle East and into Eastern Europe. But the two largest economies, I think France was about -- when I say a breakeven was just about equal to what it was last year. Germany was down, yet the other countries were up.

It's really the strength that contributed to that 3 percent from Italy and the Southern portion of Europe?

Exactly.

With regard to the industrial and automotive equipment, your margins were clearly just absolutely outstanding. How sustainable do you think those levels are?

I think that certainly we are seeing a strengthening market, and I think we've said this before, is that we don't have to add a lot of infrastructure to support the growth in that business. I think that the margins certainly at this point we would see that they should shouldn't be deteriorating from where they are.

My final question regards your contractor segment. You commented in your press release that higher sales were driven by new product introductions, good housing market and foreign growth. Can you maybe break down a little bit or give a little more granularity out to how much each of those factors contributed?

I don't think we can break it out numerically for you because it is a combination of all of those things and really the new product side is fairly typical for us. We've done a good job in the past in terms of launching new products and we're seeing that again this year. But in terms of trying to break that 8 percent into those 3 pieces, I don't have that data.

Great, thanks very much.

Michael Schneider with Robert W. Baird.

Just a follow-up on the margin question in industrial. If indeed the Euro comparisons from here begin to fade, by my calculations you will only get about 6 percent tailwind in the second quarter. Does that mean margins come under pressure actually as the currency tailwind fades?

It shouldn't come under pressure unless the currency actually becomes negative for us, and no one can know what that's going to be or when that might happen. If they are just stable, like last year, and given the nice revenue growth that we are experiencing in that business in places like the Americas, for example, I would say that those operating margins are very sustainable as long as the revenue growth continues in that business.

But the margin expansion, Mark, presumably doesn't match what you did this quarter. You basically had a 62 percent incremental margin?

That is correct.

A lot of that is driven by the currency? Correct?

That is correct. If you are looking quarter-on-quarter, that is absolutely correct. I was talking more about the sustainability of the current level margin.

And back to contractor. It is intriguing to me you mentioned the larger sprayers are doing well. Do you read that as a bullish sign for the commercial construction market?

Mike, from what we're hearing is that is exactly what's happening. We've talked to a number of people in different regions of the country; they're becoming more bullish that that commercial marketplace is starting to turn. I don't think anybody is ready to stand up and say it has turned but certainly from what we hear from our contractors, they're certainly more optimistic that the commercial marketplace is coming back.

In terms up margins for that segment, if you get a let's call it a plateau in residential demand, but an acceleration in commercial, that is a favorable mix for you, correct?

It is. Our larger units that go into primarily commercial contractor hands are higher margin units.

In terms of does breaking down home centers versus professional, Mark, do you have growth rates for what those two channels did?

Yes, I do, Mike. These are in the Americas obviously. The paint channel is up about 2 percent in the quarter and the home center was up close to 12 percent in the quarter.

The growth in the home center is up 12 percent. Home Depot isn't doing that generally speaking, same-store sales. So is this a function also of new store openings as well?

Mike, it's a combination of that. What we are seeing is that, I guess the velocity through stores is improving for our products as well as the addition of stores. Also what we had last year, that is a comparison to last year first-quarter. Don't forget we had all the bad weather in the North East last year which really had a negative impact on our sales through that home center channel which we didn't have this year.

Okay. Fair enough. And I guess final question and I will just you give you a chance to ruminate on it. Home Depot is obviously heading down a brand strategy. They even advertise about their exclusive brands, Rigid being one of them. I made probably too much of this, but curious about your thoughts on the threat of Rigid and some of the in-store brands on the Graco brand in the paint aisle?

Obviously we talk about the things that keep us up at night. That's one of those that we think about. Frankly we don't see a mediate threat in that area. If you think about what the Graco brand name brings in trying to attract that professional contractor into those stores, we still think that that brand equity is extremely strong in being able to accomplish what they're trying to accomplish into the paint department. We have heard no activity or no conversation activities so on and so forth, but frankly, we don't know what's going on in the inner circles of Home Depot. We monitor it very closely because they are our largest customer.

Is it a case where actually Wagner is probably more in the sites of Rigid than you, because of this good, better, best?

I really can't address Wagner that much. But yes, I would think that perhaps on the consumer, the do-it-yourself typer, you would have more of an opportunity to do that. But frankly Wagner has a very strong brand name in that product as well. I'm not sure how that customer base would react to it being Rigid or whatever. They've got a great brand name as well.

Final question, on contractor. Dale (ph) has talked quite awhile about penetrating these smaller paint outlets; there's thousands of them in the U.S., it isn't just Sherwin Williams and the Big Guys. Where are you in that strategy and is it indeed contributing to growth?

Honestly, there is very little coming from that action plan. The idea was to take the SM brand and sell it into some of those smaller chains. We have had some success, but not a tremendous amount of success. Honestly, there is very little of the growth that's occurring as a result of that as compared to just strong paint store sales as well as home centers sales.

Fair enough, thanks again and congratulations.

(OPERATOR INSTRUCTIONS) Charles Brady with Hibernian Southcoast Capital.

I want to come back on the warranty issues on the contractor side. I know you guys changed the warranty as of the beginning of this year. But you still obviously have some existing claims going out which I guess it is hard to accelerate. Has that leveled off or has the level changed at all and what's been the reaction to the new warranty policy in place at the beginning of the year?

I can talk to you about the reaction. The reaction was a very favorable to the plans, so we haven't seen it -- obviously the concern is that when you change any of those, you are concerned about the sales activity. We've seen it actually have no negative impact on sales activity. As far as warranty claims, I would suspect that those will continue to increase slightly probably through the first half of this year and then level out and start to tail off as we get into the end of 2004 and 2005.

We didn't see any kind of a dramatic increase in the run rate, Charlie, in the first-quarter versus what we saw in the fourth quarter.

Great, thanks very much.

Terra Conner (ph) with Wellington (ph) .

Good morning guys. That was a great quarter. Most of my questions have been answered and I just had one philosophical question. That is I noticed that in Q1 you generated a lot of cash and clearly Graco is a great cash generator. You also said that acquisitions are tough to get, prices are high. I'm curious if this trend continues, should we expect more of these special dividends which I think is very good for your stock price and it's great for shareholders?

It is a philosophical question. As I said earlier the acquisition activity is increasing or the availability of companies I guess is increasing. Frankly, even though we did give a dividend back to the shareholders this past quarter, and it's something that we should have done considering the amount of cash we're sitting on. We would have rather have employed that cash in another way. And that really is still our intent to do that. We would love to generate, continue to generate the amount of cash that we're generating and really put it to work to acquisitions and that is our number one priority.

On the other hand, if we don't end up with a good acquisition over the next 12 months or 24 months, whatever it may be, certainly we will have an issue where we'd generated cash, it's sitting on the balance sheet and we will make a decision what is the best for the shareholders at that point.

Great, thank you.

If there are no further questions, I will now turn the conference over to Dave Roberts.

Well, I want to thank everybody for participating in the call. Certainly we appreciate your interest in Graco and we love sharing the story with you, I guess. What I really wanted to do though in concluding is thank all of the 1700 employees at Graco because the results that we really achieved over the last 2.5 or 3 years considering what the economy has been has really been the result of our employees and I went to thank them publicly for that. And then final comment I guess is that we're very excited about 2004. Certainly the start has been much more than we anticipated. Frankly, we're looking forward to a very good year. With that, thank you all for calling and I guess that's it.

Thank you, this concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.