Graco Inc (GGG) 2004 Q2 法說會逐字稿

Good morning and welcome to the second-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 the international callers is 706-645-9291. The conference ID is 8058600. The replay will be available through July 19, 2004. (OPERATOR INSTRUCTIONS).

During this 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 purpose 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 10-K and its most recent 10-Q. (OPERATOR INSTRUCTIONS).

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

Good morning and welcome to everybody. Thank you for joining us. Dave Roberts and I are here to talk to you a little bit about the second quarter and to take your questions. I will start off just by reviewing some of the highlights from the press release that we put out yesterday afternoon, and then as Michele mentioned, we will open up the call for your questions.

First of all, we are pleased to report another increase in our net sales this quarter. Sales were up 9 percent, and that is our ninth consecutive quarter of sales growth. It also was our fourth consecutive quarter where all three of our divisions reported higher sales when compared to the same periods in the prior year.

In the quarter the 9 percent increase was driven by a number of factors, some of the highlights are that the Industrial/Automotive segment had sales growth of 15 percent. Our Contractor segment continues to grow. They were up 6 percent. Europe was up 22 percent, which was a very nice, nice factor for us in the quarter. And then in Asia-Pacific our sales continued to grow, and they were up 18 percent.

The favorable currency tail wind that we have experienced in the past continues to add, but not to the extent that we are seen in prior quarters. Favorable currency translation rates added about 1 percentage point of sales growth in the quarter and about 5 percent on the net earnings line in the quarter. And for the first six months favorable currencies added about 3 percentage points of sales and about 8 percentage points of net earnings growth.

Again the weaker dollar versus the euro is the primary driver for this favorable currency impact, similar to what we have been experiencing in the last several quarters. By way of reference, in this most recent quarter the average euro to dollar exchange rate was $1.21 versus last year in the second quarter the exchange rate was $1.14. So this is about a 6 percent weakening of the U.S. dollar quarter over quarter. And for reference purposes, our average euro currency rate in the third quarter of last year -- the quarter that we're right now -- was $1.13. So if rates remain at their current levels we should have a similar benefit here in the third quarter.

If you look at the P&L, the operating expenses in the quarter were virtually flat with last year. But they declined 200 basis points as a percentage of sales, from 27.1 percent to 25.1 percent. And for the quarter our net earnings are up 23 percent.

We also have been buying back stock both in the second quarter and for the year so far. In the second floor quarter we bought back about $9 million of stock. And for the year we have repurchased about $24 million worth of stock.

Next I will cover the segments briefly. In the second quarter our Industrial/Automotive Equipment division their sales were 66.5 million. They were up 15 percent. If you were to factor out the currency impact the sales were up 13 percent. Double-digit volume growth was experienced in all regions, i.e., the Americas, Europe and Asia-Pacific. In the Americas our sales were up 11 percent. And this was really characterized by strong incoming orders throughout the entire quarter and across all of the major product categories.

In Europe our Industrial/Automotive Equipment volume increased by 15 percent, and our reported sales were 22 percent higher after reflecting the stronger euro. In Asia-Pacific the sales remained strong. They were up 15 percent, or 12 percent when measured at constant exchange rates.

Profitability for Industrial/Automotive Equipment was good in the second quarter with operating margins at 31 percent. That compares to 26.5 percent in the second quarter of last year. And our operating profit dollars grew 35 percent versus last year's second quarter.

To summarize some of the highlights for IAED, we continue to see underlying growth in the Americans. Sales are up 11 percent, and year-to-date sales in the Americas are up 16 percent. Underlying demand in Europe has improved, but we remain somewhat cautious about the strength and duration of this recent trend. Growth continues in Asia-Pacific. We continue to experience strong demand for our products really throughout the region. On a year-to-date basis all of the major countries are ahead of last year's record results.

Next looking at our Contractor Equipment Division, when compared to the second quarter last year, sales of 81.6 million were 6 percent higher. In the Americas sales were up 2 percent with growth in the paint store channel offsetting a decline in the home center channel. And as we mentioned in the earnings announcement, it is important to note that last year's second quarter was especially strong due to launch of a product at Home Depot.

Year-to-date home center sales are flat. And third quarter we are expecting that the comparisons will be easier because a year ago in the third quarter Home Depot had an inventory -- a change in their inventory policy which adversely affected Graco. We talked about that at length in the third quarter of last year.

If you look at Asia, in the Contractors segment their sales were up 27 percent. Again, strong increases in most of the major product categories. Europe was up 24 percent, both from underlying growth which was up about 16 percent, and the remainder coming from the euro.

And the operating profit margin for the Contractor business in the second quarter was 28.8 percent, and that compares favorably to the 25.9 percent recorded last year. Operating profit dollars grew by 18 percent versus last year's second quarter.

So to summarize the Contractor results, again, sales were higher in all three regions. In the paint store channel some of our larger units like the Ultra Max sprayers are doing very well. In Europe the European business continues to benefit from the combination of both some underlying growth as well as a strong euro. And in Asia we continue to build our market position in airless spray equipment to serve these growing countries and economies.

Lastly, the Lubrication segment, the sales of 12.1 million were up 3 percent from the same period last year. And the increase here was pretty much mostly in the Americas and the Asia-Pacific region. Operating margins were at 21.9 percent. They are higher than the 20.7 percent reported in last year's second quarter.

Next, briefly touching on Graco's gross profit margin for the quarter, the gross profit margin was 53.2 percent versus 51.9 percent in last year's second quarter. Some of the factors that are contributing to this improved gross profit margin include some of the manufacturing process improvements that we have made, higher productivity, some reduced facility costs, higher proportion of Industrial/Automotive sales, and currency translations.

To look at operating expenses in the quarter, our overall operating expenses were 25.1 percent of sales versus 27.1 percent of sales in the same period last year. Spending was virtually flat in the selling, marketing and distribution and general and administrative expense categories, while product development spending was up as we had planned. The year-to-date product development spending was higher in all three business segments versus the first half of last year.

As a result of the higher gross profit margin and flat operating expenses our operating profit margin grew by 330 basis points versus the second quarter of last year. Operating profit margin for the third -- for the second quarter was 28.1 percent versus 24.8 percent last year. The tax rate for the quarter was 32.9 percent, very similar to our first quarter effective rate of 33 percent.

Some other items. The cash flow, 2004 cash flow from operations is very strong at 51.4 million versus 41.2 million last year. And again some of the significant uses of cash this year have been the $117 million on dividends, including the $104 million special dividend paid in March of this year, the share repurchases totaling $24 million, and property, plant and equipment additions of $6.5 million.

Accounts Receivable are up from a year ago. This is really volume related due to the higher sales activity. And inventories are also higher, again, volume related, as we are carrying a bit more inventory to satisfy our customers and higher demand environment that we're in.

To summarize Graco's second quarter was pleasing with 9 percent sales increase, and a 23 percent increase in net earnings. We still believe that we're in the midst of a recovery for Industrial/Automotive business in the Americas. This has been evidenced by our strong underlying sales growth in the last 3 quarters. We don't know how long this will last, but we are doing everything we can to take advantage of this opportunity.

In Asia-Pacific our sales remained very strong as infrastructure investments are prevalent throughout the region, and we're winning business. Our sales in Europe are higher than anticipated. And the favorable currency environment continues to add to our results. But as mentioned before, this currency tail wind will begin to fade a bit as the year progresses if currencies remain at their current levels.

And with that I will turn the call back over to Michele, and she will open up your lines for questions.

(OPERATOR INSTRUCTIONS). Mike Schneider, Robert W. Baird.

Congratulations. Obviously phenomenal margins and great growth. You really should be congratulated.

I guess first on the selling expense, Mark, I look at the numbers and you did hold SG&A basically flat year-over-year despite 9, 10 percent organic growth. Why would selling be flat with that type of organic growth?

You know, Mike, what we have done, and I think we talked about it at previous conference calls, our Industrial group is actually going through and specializing our sales force. We have actually had some reductions in the number of people selling, but we have actually higher productivity from the people who are remaining in the organization. And I think that is one of the drivers of the reduced selling expenses.

So this was the program that focused on the floor markets rather than the products?

Exactly.

So you haven't made an effort to actually cut selling commissions in any of the --?

No, no, no. By no means. No, no, our commission programs are still the same. We have done nothing there. It is primarily having a more productive sales organization than we had over the last few years.

And then on the Contractor channel, professional being up, what do you read into that vis-a-vis commercial construction? We've got mixed signals, but I guess --?

You know, again, it is very difficult for us to really evaluate commercial other than. as Mark said in his comments, the Ultra Max's were up. Those are our high-volume, high-capacity units. Our assumption is those are going into commercial real estate -- are being used in commercial real estate development as compared to residential. We think we see signs that it has started to turn, but nothing that is really dramatic that we have been able to notice.

Have you added in the professional channel -- have you added any additional major chains to that or is most of this actually just store count going up at Sherwin Williams et al.?

Sherwin Williams, really the store count is going up, but it is going up at a much lower rate than what a Home Depot would be. I think their store count is up 2 percent, I believe. I think what we're seeing is higher productivity out of existing stores. We haven't really added any additional chains with the exception of one down in Australia at the latter part of last year. But here in North America we really haven't added any additional chains, other than expanding into new stores. But the store growth in paint is really isn't very rapid.

And then final question and I will get back into queue. On the retail side, Home Depot and the rest of the guys are reporting fairly soft results. Many of the softline retailers have preannounced because of weather. Give me your outlook on that channel just in the second half. And then longer-term where does the growth come from? Is it just store count at this point?

What I can tell you is that it has been very difficult to get these numbers out of Home Depot obviously, but it looks like our same-store sales are up slightly. And obviously then you have got store growth on top of that. I think they are still talking about adding about 10 percent stores -- new stores every year. So we will continue to get growth there.

I think the climate we saw in the first half of the year really was what Mark was talking about was last year we rolled out the new 190 EF (ph). They basically filled the channel with those. I think we will see an uptick in the second half of the year. In fact the first couple of weeks that we have seen in July have been very strong in the home center channel. And we really don't anticipate that really slowing at all.

And then longer-term, is it store count or is it finally getting in Lowe's? What drives the growth in that segment or that channel?

I think you're going to have store count obviously -- is going to drive it through the Home Depot's of the world. We still focus on looking at Lowe's. We wouldn't do anything going into Lowe's that would jeopardize the business at Home Depot. But we certainly are focused on other home centers, and that certainly would drive a nice growth for us, initial growth for us, if we were able to capitalize either Lowe's or Menard's. Those are really the two major home centers.

Okay. I will get back in line. Thanks again, and congratulations again.

John Franzreb, Sidoti & Co.

Our first question is regarding order trends during the quarter. Could you discuss month by month what the volumes were like as the quarter progressed?

Mark, I don't have that data. Do you have anything --?

I would characterize it, John, as pretty consistent. It wasn't really lumpy. We were pretty much up in our weekly and monthly bookings and billing throughout the quarter.

So there was no particular softening or strengthening?

No.

Secondly, the G&A line though you took about a $1 million sequential drop off. I was wondering if you could tell me what happened there?

Part of that is the foundation contribution that we had in the first quarter. We did make a contribution again in the second quarter, but it was not as high. The remainder is really just expense management and again continuing to focus the Company and the organization on watching the spending.

And anything -- there isn't anything that really popped out when we looked through the numbers. It was really sort of an across the board reductions I guess in a lot of the different departments that roll up into the G&A line.

So a sustainable number should be between 9.5 and $10 million, Mark?

That's probably good for planning purposes.

And the last question is regarding the new facility in China. Could you discuss a little bit what went on with the planning and the timing and just a little bit about -- a little bit more color of what you're doing over there and what your thoughts are in the future?

Sure. We're going to be building a location -- actually leasing a location in the Shanghai area. The focus is going to be on our lubrication product line, along with a number of the high-volume diaphragm pumps that we produce, in addition to what we call packages or modular assemblies. So we will ship components out of the U.S. for some of our major industrial customers. We will then do modular assembly in our facility there in Shanghai and then obviously ship it regionally within Asia.

What was happening there is that we weren't driven to Asia primarily for our cost purposes we were driven primarily because the business is growing so fast there. We've got -- stated objectives of being the lowest cost, highest quality, most responsive manufacturer to our customers, and to do that we have to be local. And that really is what drove the decision to move into a facility in Shanghai.

It will be up and running probably third-quarter 2005. Obviously we're going to phase it in over the next year or so. And then we will eventually, and probably in the very near future, have engineering resources there where we're designing products specifically for the Asian market. We think that that Asian -- particularly lubrication market -- is one that will begin to take off for us. And we went to make sure that we're there to capitalize on it. And then we will evaluate other product lines as we go. But right now the main focus is on lubrication and the diaphragm pumps.

Ned Armstrong with Friedman, Billings, Ramsey & Co.

Can you comment a little bit on what you're seeing as far as some of the early indicators go with regard to the agreement with 3M for the automotive aftermarket?

Sure. For those on the call that don't know, we signed basically a business partnership with them for the automotive refinish market. Effectively we're selling what we call our Delta spray gun into there. They have introduced into three regions so far. They are selling it into the Northeast, the Southeast and into the Minneapolis area, which is the most recent rollout.

It is a phenomenal success as for both us and 3M. The numbers aren't large enough yet to really be able to talk about, but we met with 3M probably three or four weeks ago. They were telling me that their sales success -- and in every two calls they sell one vendor. So they are 50 percent close rate basically that they are selling these units to. So I think they are very happy with the spray gun. We're certainly very happy with it, and in fact, we're adding capacity in our Sioux Falls plant to be able to meet the capacity as they roll out the remainder of North America and then globally after that.

Why did you choose to focus on those particular geographies first? Is it because it is more dense from an end-user area or what was your logic behind that?

It was primarily driven by 3M. They were the ones that were -- had selected the region to roll out to. I think they felt very comfortable with the organizations they had in place in those regions and being able to support them.

You know, again, they wanted to be very focused with the roll out to make sure that you're able to deliver when the customer buys and so on and so forth. And I think they've gone about it very logically, very methodically, and I think that is part of the reason for the success. But it was driven primarily by 3M.

And just to talk a little bit more about the commercial construction market, what type of signs do you look for as indicators that that market is turning? And what in the past has been reliable for that type of predictability?

The only thing that we're really able to look is just our high-volume units, our more expensive higher volume units. And we're starting to see those increase -- and have started to see them increase over the last six months. It really is the only indicator that we have that appears that these units are going into commercial real estate as compared to residential. But I can just tell you that that market, or that product line, for us has been very strong during the first half of the year.

Charlie Brady, Hibernia Capital.

Could you just talk a little bit -- in fact on China, I know there was a trade show product demonstration you were going to back in May. And I guess you guys were to get the products in the hands of some locals. Just comment sort of on the feedback from how that went, the perception?

That was primarily a contractor business, in fact it was all contractor. We had sessions in Beijing, Shanghai and Guanjo. And they were received with incredible success. We had taken one of the larger hotels in each one of those locales, had out in the parking lots basically set up spray booths, simulating walls and different techniques, along with even the line sprayers that we had. A tremendous success. At each one of the events we had a minimum of 250 contractors, now, not painters, but contractors. They obviously employee a number of painters. And it was very well received.

We had -- I think as you mentioned we have had spray guns in each one of their hands. Frankly it was probably the best -- the most productive activity that we have in China since we have been there. Frankly, we will do more of those as we go. The idea it is to create the market there for spray.

Can you also -- just switching gears a little -- talk about as far as percentage of sales from new products introduced or redesigned over the past three years in the quarter?

I don't have that number in front of me, Charlie, but we're still over that 30 -- I think we're 34, 35 percent. We had some great new products that rolled out this year both in Industrial and the Contractor business, and I am sure we're still in that percentage range.

We actually don't compute it on a quarterly basis, Charlie. We do it on an annual basis.

Okay, Mark. Last question and I will get back in the queue. Just an update on the Matrix roll out. Is it still slated for early Q3?

Yes, right now I would say yes to that. We've got units out testing. We've had some very successful tests so far. Unless something pops up in the next month or so we are going to be very methodical about the way we go through it in the new roll out. But yes, I would say if everything continues to go well, we will probably be in third quarter.

And then on the acquisition front, any updates sort of pipeline number of opportunities? I know you said they were more opportunities than there had been, but the pricing had gone up. Is that still sort of status quo there?

Yes, I think that we're still seeing the same thing when we met back in May. We think there are opportunities out there. The prices are just extremely high from what we have seen over the last number of years. And we're still seeing that trend, but there are opportunities out there.

Matt Summerville, McDonald Investments.

A couple of questions. First, with respect to Europe, it sounds like you guys are still pretty cautious on underlying demand there. I was wondering if you could talk a little bit more about that in terms of exactly what you're seeing over there today?

You know if you look at our first quarter to our second quarter we saw a nice increase from quarter to quarter. And the great thing about it was in the second quarter is that there was no major project that we saw for the Industrial business. So it was a nice steady increase in Industrial and an equal amount of increase for our Contractor business. They were double-digit growth, both of them. And just -- both of them were just very healthy. And obviously our folks in Europe continue to tell us that the economy is weak there, but honestly the results that they are achieving are just incredible considering what the economy is doing.

How do you think volumes will hold up in the back half of the year in Europe?

I think that is very difficult to project. The numbers we looked here probably week ago said the GDP -- they revised GDP in Euroland only up 0.1 of a point. So I think they're projecting at 1.6, 1.7 for GDP growth this year. So frankly I would still be very reluctant to say that we going to see some ongoing growth there. But I don't see any indicators that would say that it is not going to.

And then with respect to the fact that you have held your operating expenses flat year-to-date, to what extent do you think you can do that through the remainder of the year? And will we continue to see the growth in new product development spending that we saw year-to-date as well?

The simple answer to that question is yes. We don't have -- we have minimal additions that we going to make to our general expenses. Product development in fact we still do have all the engineers we have been recruiting onboard yet. We've got just a few to add. And it has been a planned addition, rather than bringing everybody in all at once and trying to train them. But we will see additional expenses being created in the product development area as we work on new projects and then have additional people on these projects.

And then just a follow-up. Mark, you had mentioned that you guys continued to repurchase stock in the second quarter. Do you have a share count there? And then in discussing the Contractor business you mentioned the paint store channel was up, home center channel down. Can you put some numbers on those?

The share repurchases in Q2 were about 300,000 shares, Matt. And year-to-date share repurchases are about 850,000 shares. The breakout between the professional paint channel and the home center channel in terms of percentages, we really don't disclose it. I would say that there was some very modest topline growth in the professional side and single digit, low single digit, kind of decline in the home centers in the quarter.

Mike Schneider, Robert W. Baird.

Could you give us a sense in the industrial market, especially in the Americas, where the strength is coming from? I know it is a diffused series of customers for you, but anything that stands out?

There's really nothing that jumps out at you, other then I can tell you that our sealants and adhesives business has been very strong, and our protective coatings business has been very strong. But we have seen growth in all 4 segments, that being obviously the other 2 processes and finishing. But we had a very, very strong quarter as well as first half of the year in both protective coatings and sealants and adhesives.

And what type of customers would each of those serve?

Well, protective coatings customers are those folks who are obviously spraying in wall insulation, other types of protective coating applications. Sealants and adhesives are just general industrial, everything from automotive to any small manufacturing plant that needs a sealant application or an adhesive application.

And the growth in Europe, it does strike me you guys are far outgrowing what GDP is doing over there in the industrial space. How much of this do you believe is just your currency advantage right now?

We look at that. It certainly has helped us, but it is not the main driver of the growth. I think our folks have done a very nice job. We've introduced some new products there in both sealants and adhesives and finishing that have been nice growth drivers for us. And we're seeing some real growth coming in those areas that are very near double-digit.

We really haven't done anything, Mike, proactively in terms of pricing as a result of the movement on the currency. We have really continued to price our products to the customer competitively with the other companies that are out there.

That, Mark, by definition if you're not raising prices commensurate with the currency, you're either forcing your competition to slash prices or presumably walk away from the business, right?

We pricing in euros, so that is not true.

Fair enough. And then on the issue of pricing, if you look at organic growth either for the second quarter or for year-to-date, do you have a sense as to really how much in point terms how much is driven by price increases and how much is actually units?

I can tell you that price increase is minimal at best. Like every other manufacturer in the world we have had a very difficult time getting price, and very little of our growth is price.

Then I guess it begs the question, how are you guys able to sidestep the rise in commodity prices at this point? I know you're not a big consumer, but clearly productivity is far outpacing what materials inflation is. (multiple speakers) specifics please.

Yes, that is what really has helped us. If you look at our volume spending, or our volume and spending in the manufacturing operations, they are able to offset the cost increase for materials. We're getting cost increase just like everyone else, and our guys have been able to offset it with productivity improvement.

What are you still doing? Your plants were running efficiently 2 years ago. Where are you still finding opportunities?

You know we are asked that frequently. It is just throughout the organizations. We continue to have Kaizen in manufacturing and our 3 manufacturing facilities. We continue to invest in manufacturing technology. You know, new C&C machining centers, whenever it may be. We continue to make those investments. It is really across the board. There's not one thing that we do it's -- you walked our our plants, Mike, and it is the cellular concept and those cell managers drive to reduce their costs every day. And that is what they're driven to do and that is how they are rewarded. And so there is not one thing I can tell you.

You mentioned you are expanding South Dakota. Talk about the manufacturing footprint, maybe aside from China. Are you guys bursting at the seams in Minneapolis right now or Minnesota?

We are certainly -- if you look at our riverside facility, which is downtown Minneapolis, we're very tight there. And in fact part of the reason to go to Asia is not only for a competitive product in our Lubrication business, but also to give us some additional capacity in Minneapolis.

Our Roger's facility, which is our Contractor division, we have some space there. But we have no plans to do anything with it today. And then still in Sioux Falls we've got space that we can fill. We moved into here last April, I guess it was, was when we shut down the Santa Fe Springs facility and moved in Sharpe there. We still have space in Sioux Falls. The issue that we have, more so than floor space, is the machining capacity. And we continue to add machining capacity to give us additional capacity in the facilities.

And then a final question, just on the Lubrication division. Any roll out scheduled for the second half or wins that you can report that would benefit 2005?

All I can tell you is that we're -- in the past we have viewed Lubrication as -- and I don't want to call it a cash cow -- but we're very opportunistic for product development. We have a five-year product development plan now in place for each of the 3 divisions and we're executing to that plan. When we add engineering resource, we added it each of the divisions. So I can tell you that we are working on new products for Lubrication I guess.

And I guess I meant more so in terms of store roll outs. Meaning (multiple speakers) Sears or if it is still the Wal-Marts of the world you're working on? There's no incremental project wins?

Exactly, it is just blocking and tackling, Mike. As new stores open we continue to get those new stores, but there is no one big project out there that we're looking at that would have a dramatic impact on the business.

(OPERATOR INSTRUCTIONS) David Jarrow (ph) with T. Rowe Price.

Just two quick questions for you. If you look at the Industrial business on a sequential basis, you look like your sales are up roughly 5 percent and the margins were down 180 basis points. I'm not trying to complaint about 31 percent operating margins, because that is pretty impressive. But could you just address that for a second, why were margins down sequentially on the Industrial side?

And then a second question. The contractor business, again sequentially the margins were up about 800 basis points. And if I just look at the last six years of data here the average has sort of been up 400 basis points and the range has been sequentially up 300 and 600 basis points (indiscernible) basis points. Could you talk about those two things?

Mark, I will you take that.

Okay. The Industrial/Automotive, I don't really know that there is anything specifically there that I would comment on in terms of the sequential declines in operating margins. Really don't manage the business on a quarterly basis. On any given quarter you can have various noise running through the P&L.

Certainly my comment would be basically that we feel that the business is well leveraged. And the one area that we are increasing our spending in is the product development area. And I know that that area in Industrial/Automotive has increased.

On the CED side, again, looking at the quarters can be sometimes a little dangerous. But we had experienced significant topline growth here in Q2. And obviously a lot of those fixed costs that that division has get more leveraged in Q2 than any other quarter. So if you look historically I think Q2 has tended to be our highest profitability quarter over a long-term period of time.

The other factor in Contractor is they have done a pretty good job this year of looking at ways to take some of the costs out of their products. We have teams that are charged with the responsibility of looking at sourcing, and the engineering and the design work that going into some of our products, and we're starting to see some of those benefits also translate into a little bit better profitability for us at the gross margin line.

Let's see if I can follow-up on the industrial side. Given the higher (indiscernible) spending, has the run rate -- I am really thinking about future quarters in future years is really the level that you saw in Q2 as opposed to Q1. Is that a fair comment to make as we ramp up on the product development R&D spending?

I think that Q2, like Dave said, we're still recruiting some people, so there may even be slightly more on the R&D side as we work through the latter quarters there. It should be closer to a run rate then what you saw in Q1 for sure.

If I could follow-up on the Contractor business. The internal growth in Contractor in Q1 versus Q2 wasn't that much different. And again actually if you looked at it through (indiscernible) 6 years of data, it is between sort of 3 and 6, and you got 800 basis points this quarter. I am just wondering if there's anything else that (indiscernible) you do a better job taking costs out? (multiple speakers) other quarters?

David, I think we have done, and Mark mentioned, part of our engineering resource additions that we made were also cost reduction teams in each one of the divisions. Our focus has been generally in process improvement as compared to product improvement or product cost reduction programs in the past years.

What we did is we basically have been looking at each one of our divisions, and we have given them resource to be able to go through and to look at existing product design without sacrificing any quality or feature, and to go in and to determine if we can take costs out of that product. And I think that is what you are seeing in the Contractor business. I think they have been a little more aggressive, and have been more successful I guess, not as much as aggressive, as the other divisions have.

That fair. Can I just follow-up also on the European -- growth in Q2 in Europe in (indiscernible) industrial was obviously much better than it was in Q1. And you talked about the economy is not really improving that much. I guess what I'm trying to get at it, as you look at it today, do you think the European business in the second half of the year and in contracts with Industrial will actually slow down? Or do you think -- is it more like Q1 or Q2, trends I mean? How are you thinking about that right now?

I think I would continue to expect that we deliver the kind of results we have through the first two quarters in Europe. But again I have nothing to base that on, other than we know that we have been very successful in taking share in each one of those areas. So we will continue to do that. But I can't really give you a good feeling for what we think that business is going to be, certainly second half, third half -- second half of the year or into next year based on what we're still seeing with economy there.

Just two last questions. Mark, can you give us what the contribution for the Graco Foundation was this quarter, and how you look at the full year for Graco Foundation?

The year-to-date contribution is about 1 million 7, and in the quarter it was about 700,000.

And we look at quarterly as we go. And we could potentially make another contribution to the Foundation this year.

My apologies, last question, I promise. Just to comment on the Industrial. As you add -- historically the Industrial business has had higher margins in the second half than it has in the first half. I'm just wondering as you make these higher product development in R&D expenditures in the second half of the year, does that mean that the normal seasonality is offset? Would you actually be looking for lower margins in the second half than the first half because of this ramp of R&D. Is it that big or is it just the sequential, seasonal improvement of margins is less than normal to you?

I think it is probably more a sequential improvement more than anything. Again, as Mark said earlier, I wouldn't put much credence in one quarter's worth of results in the organization. I think we do have some seasonal expenses and margins that run through the P&L, and plus the fact that depending on what product line is selling. (multiple speakers).

I guess what I was just trying to get at is since we don't know the magnitude of these incremental expenditures, I am just trying to ask you if that sort of trumps the normal seasonality, or does it just make the seasonality less than it normally is?

That's a tough one for us to answer, Dave.

I don't know how to answer that, right.

There's way to many variables in the P&L that could impact it.

Thanks very much. Nice quarter.

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

We had a very large audience this time on the call. I really appreciate people taking interest in Graco. We certainly appreciate people spending time to hear the conference call.

I would like to take an opportunity also to thank all of our employees. We had another great quarter. And without those folks working hard every day we wouldn't be able to deliver the results we have. So all in all, thank you very much for your interest, and that's it.

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