Graco Inc (GGG) 2005 Q3 法說會逐字稿

Good morning, and welcome to the third quarter 2005 earnings conference call for Graco, Inc. If you wish to access a replay for this call, you may do so by dialing 800-405-2236 within the United States, or Canada. The valid number for international callers is 303-590-3000. The conference ID number is 11041641, and the replay will be available through October 27, 2005. At the request of the Company, we will open up the conference for questions and answers after the presentation.

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 purposes of the Private Securities Legislation 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 2004 annual report on form 10-K and its most recent 10-Q.

As a reminder, this conference is being recorded today, Monday, October 24th of 2005. [OPERATOR INSTRUCTIONS]. I would now like to turn the conference over to Mark Sheahan, Chief Administrative Officer. Please go ahead, sir.

Good morning. Welcome everybody. Dave Roberts and I are here this morning to review our third quarter results and to take your questions. I will start out by hitting some of the highlights from the press release that we issued this morning, and then we will open up the call for your questions.

On an overall basis, first of all the underlying growth that we've experienced here so far this year continued. We had growth in three of the four businesses. In all three of our business segments, I should say this quarter. That marked our 14th consecutive quarter of revenue growth over the prior year's quarter and also our ninth consecutive quarter where all three segments reported revenue gains.

As you saw in the release, sales were up 19% in the third quarter. They came in at a record $176.9 million. Sales increased 8% without acquisitions. And adding to the strong organic growth was the revenue associated with the acquisitions which was approximately $16 million in the third quarter.

The 19% increase in third quarter sales can really be summarized as a combination of growth in the Industrial Automotive segment., Their sales were up 31%. They were up 7% without acquisitions.

In the contractor segment sales were up 10% in the third quarter. And lubrication equipment sales were up 3% in the third quarter. For the quarter net earnings and earnings per share were both up 7%. Next, I will touch briefly on each of the three segments and how they performed during the quarter. First of all in the Industrial Automotive Equipment segment sales were $88.1 million. They were up 31%. Again without acquisitions they were up 7%.

They had growth in all three of the geographic regions, The Americas, Europe and Asia Pacific. Without acquisitions third quarter sales in Europe were up 8%, while year-to-date sales in Europe are up 9%. Without acquisitions in Asia, industrial automotive sales were up 11% in the third quarter, and they're up 19% year-to-date again without acquisitions. On a global basis without acquisitions, all of the major product categories, process, protective coatings, sealants and adhesives and finishings are all up on a year-to-date basis.

The operating margin that was posted in the third quarter was 26.8% of sales that compares to 33.3% last year. If you were to exclude the impact of the acquired businesses our third quarter and year-to-date margin in the industrial automotive segment would have been higher than last year. In summary, in iNdustrial Automotive we continued to see good demand in the quarter across the major product categories and in all the geographic regions, and as we head into the last quarter of the year the business tempo in the industrial automotive segment appears to be good.

Next, turning to our Contractor segment the sales for the quarter of 75.3 million were up 10% versus last year. In the Americas, sales were up 8%, driven by growth in the paint store channel. In the home center channel sales were slightly lower than last years third quarter, really as the result of inventory changes at Home Depot. Out the door sales remained strong at Home Depot and our new product sales continued to do well led by G-Max sprayers, the new 390 and the Mark V texture unit that we talked about in the past.

Our sales in Europe were also higher in Contractor. They were up 27%. Increases in all the product categories and throughout all the regions. The team in Europe has continued to be focused on end user conversions and that process is working well.

Our operating profit margin in the third quarter was 26% versus 27% last year. Operating profit dollars grew 4% versus last years third quarter. Year-to-date operating margin for the Contractor business again is 26%. That's flat with last year's year-to-date operating profit margin. Year-to-date operating profit dollars are up 12% in contractor.

Next, looking at our Lubrication segment the sales in the quarter for the Lube division were $13.6 million. That's up 3% from last year. And year-to-date sales are up 15% from 2004. The business is experiencing growth in all of the major product categories. Operating margins were 24% in the third quarter, versus 26% last year. And year-to-date operating margins are 26 percent, up over 200 basis points from the year-to-date numbers posted last year.

Looking next at Graco's overall gross profit margin for the fourth quarter. The gross profit margin expressed as a percentage of sales was 53.5% for the third quarter. That's up 190 basis points from the second quarter, but it's below last years gross profit margin of 55.1%.

When compared to last year's third quarter the lower gross margin can be attributed to the acquisitions. Before the effect of acquisitions, third quarter gross profit rate was higher than last year. Reviewing the operating expenses for the quarter, Graco's operating profit margin expressed as a percentage of sales was 26.5% for the third quarter versus 29% last year. Operating expenses increased by 90 basis points from last year's third quarter.

The increase in operating expenses as a percentage of sales and the overall decline in the operating profit margin from last year again can be attributed to the acquisitions. Before the effect of acquisition, third quarter operating profit margin was higher than last year's. The tax rate for the quarter was 33.5%. That's very similar to what's been experienced in the first half of the year.

And some other items worth mentioning: Year-to-date cash flow from operations was very strong at $110.2 million. That's up 17% from the same period last year. Some of the significant uses of cash this year have been acquisitions, $103 million. Dividends, $27 million. Share repurchases, $35 million. Plant, property and equipment additions of $12 million. Net debt was essentially zero at the end of the quarter. We've really paid off all the indebtedness incurred to acquire the two businesses earlier this year.

Free cash flow which is defined as cash from operations minus capital expenditures was $97.4 million versus $84.3 million last year. That's a 15% increase. In summary, Graco had another record quarter. This was our 14th consecutive quarter of sales growth versus the prior year. And our 15th quarter of net earnings growth. Business tempo was good at the end of the quarter.

All segments and geographies had decent tempo at the end of the third quarter heading into the fourth quarter. The businesses that we acquired are contributing to our cash flow. We are working diligently to execute our plans for improvements in the profitability of the businesses. That concludes the opening remarks, so Mary, I will ask you to open up the call for questions. Mary?

Thank you. [OPERATOR INSTRUCTIONS]. Your first question comes from Michael Schneider. Please state your company name followed by your question.

Robert W. Baird. Good morning, guys. Maybe you could address margins in Contractor, guys. The acquisitions are weighing on the Industrial segment but yet Contractor was down 150 basis points year-over-year with no acquisitions and a seemingly better mix. Could you just give us some color on what's occurring?

What's going on in the contractor business, Mike, with both our largest two customers anyway, both home center and the professional channel is that we continually come under pressure for marketing rebates. Those kind of issues which generally push down margin and that's really what's happening in that business over the last, oh, probably nine to twelve months or so.

And on a year-to-date basis, again, the year-to-date operating margins are very similar to where we were last year. At 26%. When you look at it on a quarterly basis you might see some swings up and down. Again, when you look over a longer time period there, they are pretty consistent with last year.

This is a case where the volume rebates are kicking in at year-end because of the strength of the businesses?

Yes, that's really what you are looking at is the businesses continue to be strong. You start to move into other rebate categories. And it's generally the nature of the business.

The outlook then for the fourth quarter, are we looking at similar margin declines in the fourth quarter, or do you see relief then?

You mean an additional decline in addition to -- ?

No, the year over year decline was 150 once this quarter and actually almost negative leverage.

Right.

What are you looking for as we head into the fourth quarter and in particular what does it really imply for '06?

I don't see an increase in the rebate. I don't see an acceleration in the fourth quarter on the rebate side, if that's what you're concerned about.

Right. Obviously we don't forecast what's going to happen in the fourth quarter but as Mark said, the rebate level shouldn't increase as you go into the fourth quarter, Mike. That obviously next year starts anew.

And when you look into '06, though, given the strength of the business, then do you ramp or raise the threshold for rebates to restore profitability in this business, or is this fundamentally a less profitable business today?

Oh, I don't know if it's a less profitable business. I think that as volume increases, you would anticipate getting some cost benefit out of the manufacturing area to offset any rebates that you end up giving to the customers. I would hope that the margin levels would hold in this area, and I would hope that they would be equal to what we are going to end up generating this year.

I guess then it just begs the question for the first half. Is it a case where you simply were under-accruing for the rebate programs and just didn't anticipate the strength that's occurred through the year? Or has there been a change in the contract terms?

No, there haven't been any change in contract terms. I think what it was is as you may say, or as you said, is that the business has strengthened. Certainly that has put us into a next category for rebates. There has been nothing out there that would indicate that these would get worse next year.

Okay. But, again, it looks like if you look at versus your plan and what you were accruing at, presumably business was better than you expected and you were under-accruing for rebates in the first half?

No, we weren't under-accrued for rebates in the first half. That, the first half operating margin again was right around that 26% level which is where we are at year-to-date, and I think that we would expect that going forward, as long the revenues continue to be in the range where we've seen that that's a reasonable range that we should be in.

Okay. And then the discussion about inventory seems to conflict with the strength in the business. If contractor business is strong, and sell-through is strong and these guys are hitting volume rebates why would the Home Depots of the world be reducing inventory at this point.

Mike, they generally go through a stage at least once a year and sometimes twice a year, and I don't know if it has to do with their business. I mean that's the same question that we ask is, when your out the door sales are certainly strong, why would you end up reducing inventories? It's very difficult for us to answer that.

I don't know if they are looking at end of year and they want to keep their inventories down based on reporting responsibilities or what. I have no idea. But they do this once and sometimes twice a year.

Okay. And then any unusual expenses running through? Last year we had this Home Depot I guess sales rebate.

The ISSI.

Anything like that that's been running through the quarter or any new programs?

No, no, there are no new programs particularly at Home Depot. Really nothing in the, on the professional side as well. No, there aren't any.

And then along that SSI program, the statements were made when that was rolled out that you would actually see savings by reduced personnel after the fact. Has that actually come through?

Yes, we ended up reducing, I believe the sales force went down six heads at the start of the year. And it hasn't offset what we ended up having to rebate Home Depot for from the ISSI side but we did reduce the sales force.

Okay. And then just, Mark, on the Graco foundation did you play catch up this quarter for the year?

No, we haven't made any contributions this year to the foundation.

Okay. Thanks, guys.

Our next question comes from John France remember, please state your company name followed by your question.

Sidoti & Company Could you review the status of the integration, where we stand on the acquisitions maybe how long until those businesses can contribute Graco type margins?

John, I think what we stated was within 24 to 30 months we would see those businesses running at Graco-like margins. We closed the Palm City, Florida, plant here a few weeks ago. We are in the process of moving the spray gun manufacturing out of Lakewood, New Jersey, into Sioux Falls, South Dakota. The fast-set foam equipment is coming out of Lakewood, New Jersey, into Minneapolis. We would hope to have that up and running early first quarter to late first quarter, '06.

And then, there are a variety of other changes that will occur. We had three manufacturing plants at the start of the year. We ended up with seven with the acquisitions and are really taking a strong look at how many facilities we need going forward. What you are seeing today are primarily all of the costs associated with getting ready for the integration. I think will you certainly in the next year to two years will see those companies coming up to Graco-like margins.

And you mentioned the gross margin was up year over year, ex the acquisitions. Do we have a number for that?

We don't have a number but it was up. It wasn't dramatically higher but it was higher.

Right.

Okay. And the last one, the operating cash flow was pretty significant in the quarter. Less than two years, just taking a quick glance back, what's going on there, Mark?

We are doing a better job in collecting our receivables, manufacturing our inventory and, of course, the higher level of sales in absolute dollars are stronger as well. So we are focused on cash flow. We always have been. We think that's the best way to generate value for the shareholders and I think you are seeing some of the results of that.

Okay. Thank you.

Your next question comes from Matt Summerville. Please state your company name followed by your question.

Good morning, KeyBanc. A couple of questions. Can you guys talk more about what you saw in July, and what that meant for each one of your businesses if there's any numbers you can put around that in terms of how much revenue maybe was hurt by lower demand relative to the other months?

Yeah, Matt, it was really an unusual situation for us. We came out of June with fairly strong orders. We got into July, and basically across the business. And it was extremely weak. And then we saw it points back immediately in August and September.

And again I think Mark said in the press release, we saw nothing that would indicate that it was softening at all. It was an unusual July for us. Number wise, $10 million, perhaps, in revenue that wasn't generated in July that we would have loved to have had. But it bounced right back in August and again September was stronger than August.

Okay. And then a couple of follow up questions. You know, first, if you look at Lubrication, growth was 3% obviously you had been coming off of what was an unsustainable rate, 15 percent-plus rate level. Are we coming back to a normal level, is that where you are at and can you talk about why margins in that business were perhaps down year-over-year similar a walk through you did on Contractor?

Yes. Matt, I think what you are seeing in Lubrication is more the norm. I think we said in our conference calls in the first and second quarter, is that you can't expect this business to run at 20 to 15% growth rates. What we saw in the gross margin line is that the expenses for the China plant that is under construction flow through the Lubrication P&L.

So the decline in margin really is the impact of the China plant expenses that are flowing through there. That plant is under construction. We will probably be up and running late in the first quarter of next year.

Okay. And then do you have a number in terms what have those expenses were in Q3 and what we should kind of think about for Q4?

I don't have -- Mark, do you have anything?

No, it was about $0.5 million.

In Q3, Mark?

Right.

Any thoughts on Q4?

I think most of the, most of it's pretty much, there should be some. It's not going to be --

Matt, for the year I think we are about $1 million that have flowed through Lubrication and then the vast majority of that should be complete.

And then as far as the unallocated expense that you report in the earnings release here looked like an income of 700,000 you had been running, that had been running at a negative number. Can you reconcile that, Mark?

Yes. I mean we have the normal things in there, cash discounts that we earn and cash discounts that are paid by Graco.

In addition to that, we did have some corporate allocations related to the acquisition that were running through that line with respect to some of the inventory that we are seeing in the businesses, that we had allocated expenses to the divisions and then sort of pulled them out down at the corporate level.

Basically inventory step-up ended up not being quite as high as you thought?

In essence the inventory values were not as high as we thought.

Okay. Okay. And then what thoughts do you have on pricing in your businesses moving into the next year as raw material costs are continuing to escalate?

Well, I think there's some possibility for prices. I think Mike asked earlier about the Contractor business. I think you'll have a very difficult time getting price on the professional side as well as the home center side. I think we have a little more potential where leverage in the Industrial business as well as the Lubrication business to be able to get some price. Now that's on existing product. What is good about our business is that with the new product introductions in Contractor we will get some price on that in the, in the coming years.

Can you talk a little bit about your new product pipeline in that business when you might have meaningful anticipated launches.

Yeah, we generally launch all of our new products January of each year. That has not changed. We have some products coming out and this is in the Contractor business now. We have some products coming out that will be introduced just at the start of the year as with every year. We go through our renewal strategy and we renew the product line every 12 months.

Just one last one and I will hop back. Mark, can you update share repurchase activity for the quarter and full year and how much you have left on your authorization?

Well, we have bought in about $35 million year-to-date, I think around $275,000 in the third quarter. And we still have a significant authorization left, I think somewhere around 1 million shares remaining under that program. And that program expires in February of 2006, which we'll be going to the board looking for approval to have a new program at that point in time and, of course, we could always increase that amount by going to the board before that if necessary.

Okay. Great. Thank you.

Our next question comes from Charles Brady. Please state your company name followed by your question.

It's Harris Nesbitt. On the foreign exchange contribution, I know in total you said it was immaterial but across the three business units, was there any meaningful addition?

No, no. It was really pretty vanilla here in the third quarter across all three businesses.

Okay. Can you just talk about the acquisition pipeline going forward? When you guys are operating at sort of the margin levels you are at obviously finding acquisitions that are going to be more, contributing more meaningfully quicker gets more difficult to do. What are you seeing on the acquisition front? What's your appetite level these days?

I think Charlie what we ended up doing is that we will be opportunistic when the acquisitions come about, if there's something out there that we run across that looks very attractive we certainly would pursue it. I think our focus right now is to integrate the three acquisitions that we have made this year.

We recognize that those businesses don't run at Graco margin levels, and really that's, now that we've made the three acquisitions we've got to put our people working on improving the margins of those businesses and that's what we will do. But that doesn't mean that we have stopped making acquisitions. We will certainly look for and continue to talk to people who have businesses that we are interested in. And if any of those would come about we certainly would pursue it. But we are going to be more opportunistic at this point rather than aggressively looking for acquisitions over the next six months or so.

Okay. And then can you just talk about any impact, higher transportation or freight costs are having on your business or just input for material costs as well.

We continue to have material cost increases. Freight costs, yes, there are some freight costs increases along the lines of surcharges for fuel, so on and so forth, but they haven't been that dramatic. I can't give you the dollar amounts but certainly there have been some cost pressures as a result of those. We found that the material costs have slowed as compared to last year. But there are still cost pressures and basically anything related to petroleum or obviously steel.

Thanks so much.

Okay.

Our next question comes from Ned Armstrong. Please state your company name followed by your question.

Ned Armstrong with FBR. I had a question regarding the Industrial segment. Did you mention what the sales growth was year-over-year in the Americas?

We didn't but --

We can get it for you here. For the quarter, Ned?

Yes.

With or without the acquisitions, I assume, that's what you are looking for?

Without the acquisitions, that's correct.

It was up 5%.

5%. Was that number spread roughly evenly across the different businesses? Was there any one that was dragging it down or --?

I don't think -- there was no drag on it. as you look across the businesses, our Protective Coatings business grew as you would you expect at double-digits. Finishing business was relatively strong. Process business was strong. The normal Graco SAE business wasn't as strong as the others but it still grew. So there was nothing in there that really drug anything down. Just that the SAE business was a little lighter than the others.

No end markets were particularly weaker than the others, either.

You know, our assay businesses, we take about our exposure to automotive, it's probably more related to exposure to automotive than the other businesses. And it's the reason we bought Liquid Control to diversify it. I think it's any softness that would you have seen in SAE would have been related to automotive.

Juan I'm look when I look at the sequential quarters, third quarter versus second quarter in '05 and '04, last year you were actually up a tad, I believe, sequentially. This year you were down roughly 6% sequentially. Is there anything I should be reading into that or something that is obvious that I'm missing?

I think the numbers really are sort of what they are. There is nothing funny in the numbers. Or there is no other items in there that we haven't spoken to. I would say that to be frank with you, Management and the Company we really don't get too hung up on quarters. We look over longer periods of time when we are trying to analyze and if you look across these businesses, particularly when you strip out the acquisitions we are pretty satisfied with the overall profitability levels of each of the businesses so far this year.

Just to piggyback on that, I think that Mark brings up a good issue is that as we look at our core business, the core business is still very good. The margins are good. There's good growth going on. The challenge that we have as a management team is integrating the acquisitions and we have seen nothing at this point that would cause us concern with being able to do that.

Then relative to the acquisitions, as you're talking about the costs going forward, you are actually talking about the various costs involved in integrating the acquisitions rather than any inventory or other asset step up costs?

That's correct. Now I think we've looked at the as you say the asset step up costs. I think those are behind us. What we've got going forward are really the issue of now integrating the acquisitions, getting to a point where we have the right number of factories for the size of the business. And the right skill levels in the appropriate locations.

Great. Thank you.

Okay.

Your next question comes from Andrew Cash. Please state your company name followed by your question.

Hi, UBS, just a few questions if I could. As far as the seasonality question just brought up. I know you don't look at things from quarter to quarter, but would you say that the integration cost of the acquisitions is actually increased somewhat in the third quarter compared to the second quarter?

Well, there were costs, I guess more costs associated with actually integrating as compared to any asset reallocation that we did. If you look at this quarter, there was some stay bonuses that were accrued for. There were some severance costs that were associated in the third quarter that we didn't have in the second quarter. So I think the costs that you are seeing now are those associated with integrating the acquisitions.

So would you expect those to be sort of at a similar level going forward or would they taper off a bit?

I think in the short term they won't taper off. I think you will see costs in perhaps the same category or the same size over the next quarter or so, and then would you expect them to taper off as you get things up and running the way would you like.

Okay.

I think, too, we all have some variability in the quarters and to the extent that they are significant items and are related to these things we will discuss them and let you know what they are. But there could be some variability there going forward as we make management decisions.

Alright. Do you guys have any good, do you have a good read on your customer inventory? I'm thinking the distribution, most of your sales go through your distributor network, do you have a good read as to what's happening with their inventories?

Well, I think the great thing about the business that we have is that our distributors don't carry a lot of inventory other than when you start looking at the two major contractor customers. What you have is that in the industrial side they carry very little finished goods inventory but they carry parts inventory. And I have seen nothing that would indicate that there's an inventory build in any of our customers.

Okay. Good. As far as steel costs are concerned, I've been watching at least in cash indices where [caldwell] steel is starting to rollover and starting to down. But overall you are still seeing increases in steel costs?

I think there is still some upward pressure, Andy, but it's certainly much less than it has been and I think that we are anticipating like you are that as you get certainly into next year that you see those costs starting to come down.

A couple more. Home Depot, when does that inventory adjustment calendarize itself or is that the way to think about that?

They made an adjustment. They do this frequently like we said. A typical example would be where they would normally be carrying a certain level of inventory a number of weeks, for example, they would arbitrarily take that down to a lower level of weeks. I think they've, that can happen at any time, Andy, we think that this most recent one they have pretty much rolled through the stores. But again it's up to them in terms of when they want to do these things. They have typically done it in the summertime frame similar to what they've done this year. But it's really their call in terms of what they do.

So whatever level of inventory that they have of your products you are saying it may actually, they may rebuild that inventory back and in the next quarter or two quarters from now?

Anything is possible, yeah. They tend to move those numbers around so.

Okay. All right. Thanks so much.

Sure.

Your next question comes from Kevin Monroe. Please state your company name followed by your question.

Good morning. It's Thomas Weisel Partners. Just wanted to ask about the Industrial Automotive segment again. Your organic growth there has slowed down quite a bit from the last quarter. Just wanted to get your thoughts on why the slowdown and is this kind of a more sustainable growth rate going forward? What do you think the long-term growth prospects for that segment are?

I think organically that business, we've always said it should grow about two times GDP and I think that's what we saw in the third quarter. I think that we had superb growth certainly in the first half of the year. The good news is that it's growing certainly in the areas where would you like it to grow and that's Eastern Europe and Asia and I don't see anything out there that would indicate that that would slow from the point where it is now. But again, will it I don't at the first quarter rates, second quarter rates? Probably not.

Thank you.

Our next question is a follow up from Michael Schneider. Please go ahead.

Guys, could you spend a minute on the acquisitions again? If you look at the expenses that rolled through last quarter, it was a hit to gross margins of about 120 basis points. This quarter it looks like it was probably around 200 basis points. Why would expenses be accelerating or are we just seeing the expenses associated with the moves that are going on right now?

I think that we are seeing some of the move expenses. I think that the revenues in total were lower in the quarter so when you look at percentages you can have some issues there. Those are the two things that come to mind, Mike. Again, these are, these businesses aren't as profitable as the traditional Graco businesses. So they do have a fairly significant impact on the profitability of the industrial automotive segment. And when you look at it without those in the P&L the base business is actually running pretty good profitability wise.

The other thing, Mike, if you look at the Gusmer business, much of the backlog that you saw increase in the quarter was a result of the combination of the Gusmer, what we call Gusmer Decker, the rim business, there were some nice incoming orders for that business but it's more of a project-related business so they didn't ship in the quarter so you will see those ship over perhaps the next two quarters. So there were some costs associated with those projects. But still you weren't recognizing the revenue for them.

The expenses, I know you model these things out extensively on the acquisitions, are the expenses to consolidate and work over these acquisitions, are they running above your expectations?

No, I don't think they are running above expectations. I think that what we will see going forward, though, will be costs associated with the integrating of those acquisitions. As we said earlier, it's going to take us 24 months to do that.

So in dollars where are we in this curve? Are we, is this the peak in the expenses in Q4, is it there actually some relief potentially?

I think as Mark said I think it's going to be lumpy. I can't really tell you what the fourth quarter is going to look like, other than there aren't any -- well, there are some major moves. We've got Fast-Set Foam coming into Minneapolis out of Lakewood. There will be some costs associated with that. Going forward, I think it will go quarter by quarter. There are areas that we think are appropriate to make moves at that time and you will see an increase in perhaps expenses in one quarter and then a great decrease in the following quarter.

I think what, with the stock down six, 7% this morning people are wrestling with when do we see the margins turn.

Right.

Is the fourth quarter, is the fourth quarter the period in which you actually see gross margins for the total company flat overall or do we have to wait until 2006?

Mike, if you look at the impact of the acquisitions, there certainly were the inventory impacts that we had in the first two quarters, and then there was some associated cost in the third quarter. I don't know exactly what those costs are going to be in the fourth quarter. But I would hope that there's a leveling at this point. I think the acquisitions should start to contribute from this point going forward.

Okay. And then just Q4. Seasonally you are down normally a couple of pennies from Q3 to Q4. With these expenses in mind, with this inventory adjustment that went on with the shipments that go on at Gusmer would you say it's reasonable to expect they should be flat sequentially this year given the anomalies of the third quarter?

I think that we really aren't going to give our guidance on the quarter, Mike. We don't give guidance, as you know. The numbers will be what they are and we are going to disclose all the information that we can to help people understand what they are at that point in time. But there will be, like Dave said, some choppiness with the acquisitions and if we make decisions we will highlight what those are.

We are doing these things to improve the profits of those businesses. And we think that there's great opportunities to do that. But people will need to realize that in doing that, there's going to be some expenses associated with that over time and again we will do our best to break those out.

And just to piggyback on that, there's nothing that we've seen in these acquisitions that causes us concern. There is no reason these businesses can't run close to what Graco-like margins are and it's going to take us a while to get there. I think we're still excited about the acquisitions and we think we are going to contribute at levels that are very close to what Graco levels are.

And Mark, just rom an accounting perspective, why haven't many of these expenses been reserved for at the time of the acquisition? Are these moves that were not contemplated, so under GAAP you can't reserve for them?

You can't accrue ahead of time until you made the decision specifically of what you are going to do. We are still in an evaluation mode on some of this stuff so we haven't made the final decision on exactly what the plan is. And once the plan is executed that's when you can actually take those.

In Q4 the Graco Foundation, what should we model for a contribution for '05?

Well, we will look at how the year is going and we will make that decision based on what we think the profitability in the quarter is going to be.

Okay. And then just a discussion of backlog. In eight years of following you guys I don't think we've ever talked about backlog and certainly not in specifics. Why now? What are you trying to convey by highlighting the fact that backlog is up sequentially and year over year?

I think what we are saying there, Mike, is that some of the revenue shortfall that we experienced in the third quarter was a result of this project business that we got when we bought the Gusmer business, and the Liquid Control business. We are trying to highlight that I don't think there will be a lot of conversation about backlog over the next number of years, but just the fact that we now have businesses that operate on backlogs unlike Graco did, back to the comment I made on the rim businesses. We had superb incoming order rates in the third quarter. Again, those are projects that ship over three to six months. So I think that's just what we were trying to convey to the group.

Okay. And then just finally on the inventory, for the second quarter now, inventory days are up just a hair, which is a reversal of a multi-year trend. Is it this project business that explains it or are you building inventory for some reason?

Well, I think that the certainly the sales are up so that is driven in our inventory to be up. I would not anticipate that there's going to be a significant increase in inventory as we go forward. I think we have some inventory issues that we need to work through in the acquisitions, particularly the Gusmer acquisition. It was running at turns about half of what Graco was. We think there's some upside opportunity there. The Liquid Control side, they were very close to what Graco turns were. We would anticipate those continuing. I think there's some upside, upside being a decline in revenue in the next year or so basically as we work through the Gusmer inventory and get those turns close to where we were.

Thanks again.

Sure.

Next question, follow up from Charles Brady.

Thanks. When you are looking at improving operationally, taking cost out of the acquisitions; I'm curious what your thoughts are just looking at the base business and what the opportunity for improving your existing businesses are going forward?

I'm not quite sure what you mean, the base business, do you mean the existing Graco business?

There's a lot of opportunity to take costs out and get the margins back up from the acquisitions but excluding that, what's the opportunity just on stuff you had for awhile to keep --

Charlie, as we said over the years there's really an issue, not an issue of us running out of ideas with removing cost. We made a move, just, in fact we just completed a move of our Tips factory out of our Minneapolis facility into Sioux Falls. Overall that should be a cost reduction for us. We did it to make room in the Riverside facility, but overall I think there's a cost reduction associated with that that we will see some time in the future.

And there are other moves like that that we will continue to consider. We continue to invest in capital equipment to improve our productivity. We are constantly looking for ideas and we haven't reached the pinnacle yet from a cost reduction standpoint.

Okay. Thanks.

On the backlog, is it fair to say that the increase in backlog was entirely due to acquisitions?

The vast majority, yes, yes. In fact, I don't have a breakdown.

I think about 15 million of the backlog is acquisition-related.

Thanks very much.

Okay.

Your next question is a follow up from Ned Armstrong. Please go ahead.

Yes, Mark, did I hear you correctly when talking about the Industrial Automotive that ex these acquisitions costs operating margins would have been up versus the year ago quarter?

Correct.

Okay. So it would have been in excess of that 33%?

Right.

Okay. And then just moving over to the contractor real quick do you have the year-over-year change in paint store sales and year-over-year change in home center sales?

For the quarter?

For the quarter, yes.

For the quarter, the paint store was really the primary driver of all the growth there in and home center was down a couple percentage point. The rest of the growth came from the paint stores. In North America. And, of course, when he growth in Europe this quarter as well which helped the contractor business.

Okay. Thank you.

Yes.

Your next question is a follow up from Andrew Cash. Please go ahead. Mr. Cash, your line is open, please go ahead with your question.

Thank you. A question on, an accounting question and then a question on Gusmer. The Chinese plant expansion, did I hear you right, you are taking that as an expense? I was just wondering why not capitalize that?

No, it's not totally an expense, Andy. What it is is that there are some costs associated with preparing for moving equipment or moving product out of Minneapolis into China that are expensable and that's what the expense was. No, the plant is being capitalized, obviously.

As far as Gusmer, when you look at what you guys can do differently could you highlight a couple of things you think you can do different that will would lead to much better margins?

Sure, I think that first of all just getting the fast-set foam pumping equipment out of Lakewood and into Minneapolis and then picking up just the volume increase in Minneapolis will certainly help us there.

The spray gun manufacturing out of Lakewood into our Sioux Falls facilities not only are the labor costs lower but there's increased volume, increased levels of automation in Sioux Falls which will help us on the spray gun side. The rim business that we combined, Gusmer had a small rim business, Liquid Control had a small rim business that was being done down in Palm City Florida. We closed that Palm City, Florida plant, and we're consolidating it all up into Lakewood, New Jersey, and that will give us additional volume on the rim business, just at a time that it's growing.

One of the other things, on the product side, we've been looking at this spray polyethylene foam and we are very excited about some of the opportunities that are out there in the commercial roofing market as well as the home insulation market.

Right.

I was wondering, what have you learned since you've been kicking around the Gusmer acquisition in terms of product potential? Are you surprised about some of the upside out there?

You know, we heard and I don't know if these statistics are correct or not but 3% of the insulation that is being applied today is foam. And we know that the increase in R-factor as a result of using foam, the sound-deadening qualities that we talked about, and it actually helps reduce mold in houses. We think there's huge upside in that marketplace for the foam business. I think it's just going to take time. Today the materials are, I think, I've heard they are three times as much compared to a house that actually uses the pink fiberglass in the walls but I think as the cost of materials come down I think you will see that grow dramatically.

There's one final question on that. Do you have a backlog of spray polyurethane foam equipment? Because the people that we've talked to that go out and are spraying these roofs and homes, their growth is up 30 and 40%. Year over year.

Right.

I'm just wondering, is the equipment available for them do all these jobs?

That's one of the good thing about the consolidation into our Minneapolis facility is that we can more easily handle the demand. Frankly we have been able to handle the demand today. We have a fairly sizeable market penetration from Gusmer standpoint and the Graco standpoint, and that business continues to grow for us at rates that are very attractive. We've been able to handle the growth without a problem.

Okay. Thank you.

You're welcome.

Our next question is a follow up from Matt Somerville. Please go ahead.

I just want to talk real quick about Contractor in Europe. Mark, id you share a number with respect to how much your European business was up in the quarter year-over-year?

It was up, I can give you the number, Matt. It was up about 27% in Europe in the quarter and it's up about 26% year-to-date.

Can you talk about what's driving those comps? I know you've mentioned migration to southern Europe similar to what's happening here in the U.S. There has been to be something very favorable going on with market share.

I think you're right. I think that if you looked at the contractor business in Europe, it's driven by the fact that the baby boom that we've talked about headed to southern Europe. Also I think our folks have done a very nice job in being able to capture some market share as well.

Plus I think there's a third component when we say capture market share, not only from our competitors, but also the change from brush and roller to spray, and I think they've been very successful doing that. I think you put those three factors together and that's the reason that business is up 27%.

Do you have any statistics that you guys look at in terms of the mix of paint applied, spray via brush and roller maybe a couple of years ago and then where we are today?

Again, there's no basis for this information other than we get from the paint companies. But probably, let's say five years ago, we heard that the spray rate of paint purchased by the professional painter was about 20% in Europe. We think that's now around 30%. So the, that transition is occurring, and I think it's driven by two things. Northern Europe I think is slower to adopt the spray equipment as compared to southern Europe. So I think what you are seeing is that there's more growth going on from a construction standpoint in southern Europe and then more of that is being sprayed. And I think that's driving the spray rate.

Okay. Thank you.

Okay.

Thank you. Your next question is a follow up from John Franzreb. Please go ahead.

You talked about integration acquisitions but could you just break down the sales of the businesses and they are performing on a quarter and year-to-date business and how that is relative to your expectations?

If you look at the Gusmer business, John, I think -- and again I don't have numbers in front of me but the Gusmer business actually has exceeded what we thought that business was going to do. Now there's a phenomena there that's occurring is that now that the basically we bought a competitor, I think you are seeing an increase in the Graco business as well as a smaller increase in the Gusmer business for the fast-set foams. Then if you look over at the rim businesses, as I said earlier, we just had great success over the last quarter in the rim businesses, if you look at Liquid Control, I think that we are probably equal to where we were last year. I would have hoped that we would have had that business growing at this point. I think overall it's relatively flat compared to what it was.

Okay. And just a follow up on the previous question, how much of contractor sales are in Europe?

Year-to-date contractor Europe sales are 35 million, roughly.

Okay. Thank you.

Sure.

Our next question comes from Tim Adler. Please state your company name followed by your question.

Hi. I'm from JP Morgan. A couple of questions. The first is, you were saying that in the industrial automotive segment there is no longer any impact of asset step up from the acquisitions reflected in the gross margins. Is that right?

That's correct.

But there are still some inventories associated with the acquisitions that are reflected on the balance sheet, right?

That's correct.

So those inventories did not have to be written up?

That's correct.

Okay. The increase in inventory that you showed on the balance sheet, I didn't compare versus last September but I did just from what was in the release in December. How much of that would be approximately would be attributable to acquisitions as compared to something like the change in stocking at Home Depot?

Can you give me a second here I can probably give you a number on the acquisition side. Rough number is about 15 million.

Of that difference?

Yes.

So there's not a whole lot of inventory you were caught with because of the change in stocking?

Oh, from the Home Depot side?

Yes.

Yes, that's correct. What's great about that business is our inventory turns are very high and we respond very quick to the changes in what their ordering patterns are.

Okay. The next thing I want o double-check on, the margin decline in INA that you reported, is there anything other than acquisitions that we should be aware of?

No, really if you take the acquisitions out the margin rate would actual will be slightly higher than a year ago.

That was going --

On a quarterly basis.

That was going to be my last question. When you say that the margin actually would, rate would be up, I just wanted to put that in a little bit of context. Would it be up as much as it was in prior quarters or was it up less or --?

Pretty similar. Pretty similar.

So there's no fundamental change in the business ex acquisitions at least with respect to margins?

They are better, yeah but they are not like ramping up at an accelerated rate but they've been higher pretty much consistently throughout the year.

Thank you.

Sure.

Thank you, ladies and gentlemen. [OPERATOR INSTRUCTIONS]. If there are no further questions I will now turn the conference over to Dave Roberts. Please go ahead.

Wanted to let everyone know that we remain optimistic about certainly the fourth quarter and into 2006. As I said, the incoming order rate in August and September was very strong. We see nothing that suggested that the industrial business or the contractor business was slowing.

I think our big challenge is obviously integrating the acquisitions and I think we've got a plan in place that over the next 24 months or so, you will see those businesses certainly generating Graco-like margins. With that said I would like to thank everybody who participated in the conference call and we look forward to talking to you again at the end of the fourth quarter. Thank you very much.

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