Graco Inc (GGG) 2006 Q1 法說會逐字稿

Good morning and welcome to the first-quarter 2006 conference call for Graco Inc. If you wish to access a replay for this call you may do so by dialing 1-800-405-2236 within the United States or Canada. The dial-in number for international callers is 303-590-3000. The conference ID number is 1105-7597. The replay will be available through April 24, 2006.

At the request of the Company we will open the conference up for questions and answers after the opening remarks from management. During this call various remarks 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 item 18 of and exhibit 99 to the Company's 2005 annual report on Form 10-K. This report is available on the Company's website at www.Graco.com and the SEC's website at www.SEC.gov. Forward-looking statements reflect management's current views and speak only as of the time they are made. The Company undertakes no obligation to update these statements in light of new information or future events.

At this time all participants are in a listen-only mode. Following today's presentation instructions will be given for the question-and-answer session. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded today, Thursday, April 20, 2006. I would now like to turn the conference over to Mark Sheahan, Chief Administrative Officer. Please go ahead, sir.

Thank you, Mary. Good morning, everyone. I'm here today with Dave Roberts and Jim Graner. We're going to go through some of the highlights of the press release and then we'll open up the call for your questions.

First of all, on an overall basis we saw nice underlying growth in all three of our reportable business segments this quarter. That marked our 16th consecutive quarter of revenue growth over the prior year's quarter. It was also our 11th consecutive quarter where all three of our segments reported revenue gains. Sales were up 12% in the first quarter; they came in at a record $192 million. The 12% increase can be summarized as growth in the industrial segment of 14% -- it would have been up 17% at constant exchange rates. Contractor segment was up 10% and the lubrication segment was up 16%.

Our diluted net earnings per share were up 34% and our first-quarter results included incremental expenses for stock-based compensation of about $1.5 million after-tax. They also included unfavorable currency translations which amounted to about $1 million after-tax. We anticipated that the full-year impact of the FAS 123R stock-based compensation expenses would be about $6 million after-tax.

I'll talk briefly about the segments. First of all, the industrial segment reported sales of $100 million, they were up 14%. Translated at consistent exchange rates the sales were up 17% with growth in Europe and the Americas. Sales in the Americas were up 23% and we experienced good gains across all of the major project categories and in Europe our sales were up 11% on a reported basis and 19% higher if they were translated at consistent exchange rates. In the Asia-Pacific regions our bookings were up by double-digits but our sales were down 7% in industrial automotive and they were 4% lower when translated at consistent exchange rates.

From a profitability standpoint the first-quarter operating margins was 32% in industrial versus 25% last year. And the first-quarter operating profit dollars were up 46% versus the first quarter of last year. In summary for industrial, we continue to see good demand in this segment across all the major product categories and across all the geographic regions. The business tempo, as we indicated in the press release, is good heading into the second quarter.

Next, looking at the contractor segment, the sales were $74 million in the first quarter; they were up 10%. In the Americas we had a 9% revenue growth that was really driven mostly by the professional paint channel. We also saw good demand for new product sales including our UltraMax II sprayers, our texture sprayers and our hydraulic units.

In Europe they continued to see nice demand growth for the contractor segment. Sales were up 12%, again increases across most of the product categories and throughout all of the major geographic regions in Europe. Their sales were up 21% in Europe on a constant currency basis. The operating profit margin in contractor was also up nicely. It was at 28% this quarter versus 22% in the first quarter of last year and our operating profit dollars were up 39% versus last year's first quarter.

Then on lubrication, the sales in lubrication were also up nicely; they were at $18 million for the quarter, that was a 16% increase from last year. Again, this business is experiencing growth across all of its major product categories and they're translating that into nice growth on the profit side too. Their operate margins were at 27% this quarter.

If we take a look at Graco as a whole -- the gross profit margin of the Company saw a nice rebound here in the first quarter. We were up to 53.7% for the quarter versus 50.2% last year. Last year's gross profit margin was reduced by approximately 180 basis points as a result of higher inventory costs from the acquired businesses. The remaining piece of the improved gross margin this quarter is really due to a number factors including some cost improvements in manufacturing and enhanced pricing. Those were more than enough to offset the unfavorable impact of exchange that we mentioned earlier.

If we look at the operating expenses in the first quarter -- the Company's operating profit margin was 28.4%, that compares favorably to 24.8% for the same period last year. We had a nice improvement in operating margin despite increases in product development spending. We also had about a $1.8 million of expenses related to stock-based compensation in our operating expenses.

We also had about $1 million of contribution to the Graco foundation in the first quarter of 2006 versus no contribution last year in the first quarter. Operating expenses expressed as a percentage of net sales were lower than last year as well. When you take the lower spending as a percent of sales and combine it with the gross profit margin increase it led to a record level of operating profitability in the first quarter.

A couple of other items -- the tax rate for the first quarter was 35% and that compared to 33.5% for the same quarter last year. The higher tax rate was really due to lower federal tax credits and exclusions versus what we had in last year's first-quarter numbers. Year-to-date cash flow from operations was strong at $32 million; it was up 25% from the same period last year. We used the cash to pay dividends of $10 million, we bought back $17 million worth of our stock and at the end of the quarter we had net cash of approximately $23 million.

One other item that we announced in the release this morning was an estimated $4 million to $6 million of pre-tax expenses related to facility consolidations in Lakewood, New Jersey and Villanova, Spain. These two facilities were acquired last year as part of the Gusmer acquisition and their consolidations were planned as part of those acquisitions. We expect that the $4 million to $6 million of expenses will be incurred over the remainder of this year.

Just to summarize, Graco had a great first quarter. Again, it was our 16th consecutive quarter of revenue growth and our 17th quarter of consecutive net earnings growth. The business as a whole is strong heading into the second quarter. All the segments and geographies again had good tempo. The businesses that we acquired last year are improving both on the earnings side and on the cash flow side and they are expected to continue to contribute throughout this year. That concludes the opening remarks, so Mary, I'll open up the call now for any questions.

(OPERATOR INSTRUCTIONS). Robert Lagaipa, CIBC.

Good morning, all. Just had a few questions. I guess one just a comment. It's nice to see the automotive name dropped from the industrial segment given it's so small.

Thank you. We took all your advice from last year and did that for this year.

My question are, one, just with regard to the gross margin improvement. Obviously it impacted last year by the acquired inventory, but I just wanted to dig down a little deeper into the components of the improvement. You mentioned enhanced pricing; you mentioned manufacturing improvements. Can you maybe give us some parameters as to how much was pricing, how much was the manufacturing improvements? Was there any benefit whatsoever from possibly lower raw material costs? Maybe just provide some color there.

Mark is looking up that reconciliation. While he's doing that, there certainly have been no lower material costs this year as compared to last. We continue to have cost pressure particularly in our tungsten materials that we buy and certainly in copper and aluminum. So we still have those cost pressures that we're offsetting through manufacturing process improvement. And I'm stalling here, Robert, while he -- we got it.

Robert, this is Jim Graner. We do have an overall improvement in material costs given our sourcing from overseas operations offsetting the negative impacts that Dave mentioned. So we also have nice improvements coming out of productivity processes that we've implemented in our factories here in Minneapolis that includes transition of the spray foam business from [Cosmarion] to our factory here as well as just improvement from a volume perspective. We're running more volume to the same factory so we pick up a little bit there. I would say the answer to your question is it's about two-thirds manufacturing driven and one-third pricing driven.

Okay.

We have implemented prices effective 1st of February here in the U.S., that's for orders received after the 1st of February, and the 1st of March in Asia. We should see a little bit more of that positive impact later in the year.

Can you give us some sense of the pricing actions that you've taken? Is it pretty much across the business? Is it specific?

It's really relatively spread across all of the businesses. There's some I guess variety in the amount of price increase we'd go through product by product, not only new product but also parts. I guess our effective price increase at this point might be a percentage point, but that would be about all.

That's very helpful. Just the last couple questions if I could. One, just in terms of the integration process of the acquisitions last year, typically you've said in the past that it typically takes two to three years to fully integrate an acquisition. Obviously you're seeing some productivity improvements. You mentioned the move of the spray foam, etc. Where would you say you are in that process now that we're sitting here a year later? Would you say that you're ahead of plan, on plan or behind? Maybe just give us (multiple speakers)

We're just where we expected to be. When we bought the acquisitions we wanted to learn the business before we made any facilities moves. I think our people were very quick in understanding the mechanics of those businesses and began the integration of the sales organization, marketing, the back office functions all of last year. We're now to a point where we moved some of the high-volume fast-set foam equipment out of Lakewood, New Jersey into Minneapolis and also some of the spray guns out of Lakewood, New Jersey into Sioux Falls. That was right on schedule; that occurred at the end of last year.

PBL, when we made that we actually moved it just a few days after we bought it, so that was small. But I think we're basically on track where we expected to be and I think we'll see continued improvement as we go, particularly when we finally close the Lakewood facility and expand North Canton and move the operations into there.

Sure. Well, lots of questions if I could. One, just in terms of your comments relative to the business tempo and continuing at least into the early part of the second quarter. Could you maybe just give us some sense of when we think about just the economic growth -- certainly in the U.S. that most industrial sets had seen during the first quarter, couple that with the warmer weather that I'm sure benefited the contractor division? Can you give us some sense of -- I mean, when you mentioned that business tempo continued into the second, are you going to see the same type of seasonal benefit do you think in the second quarter relative to the first, or is that somewhat muted by what I just mentioned, the economic growth that most industrials have seen and also the warmer weather?

Certainly we're not a leading indicator of the economy. We're basically lagging most economic news that we hear, particularly in the contractor business. But I can tell you that the professional side of our contractor business has been very strong. Our four largest customers are up double-digit fours. We're very concerned as we read the newspapers and press releases concerning housing starts. We watch that very closely, but we've not seen any indicator of that in our business today.

On the industrial side, the business remains very strong around the world. We were lagging somewhat in the first quarter in Asia, but the backlog was up significantly in Asia and we would expect that that would pick up in the second quarter and into the third quarter and catch up to where we would expect that business to be. Europe continues to perform very strong from an industrial standpoint as does the Americas. So really the economy appears to be still very, very strong from an industrial standpoint and the contractor business still looks very good.

How about the weather? Do you see any significant impact just because the weather certainly here in the states was a little bit warmer through the winter?

No, the only thing that the weather really impacted our business, believe it or not, is in our auto refinish business. And warmer winters usually indicate less snow, less accidents. And if you looked at a very small slice of our business, which is auto refinish, that was actually down because of warmer weather, but that's the only thing that we've seen.

And the last question before I pass the baton. Just with regard to the share repurchase activity; you had mentioned that you bought about $17 million worth of stock back. If I look at it, just run the calculation, the average stock price was about $41 which would indicate most of it was done kind of mid quarter. Can you just give us a sense of for cash flow usage going forward you're going to continue to use excess cash for share repurchase and even at current levels. Have you done any share repurchases lately? Maybe just provide some color there.

Part of the reason that I think you see what you see is because we were in a blackout -- corporate blackout period here for about four weeks prior to the conference call. So that has some bearing on the purchase price when you run the math. We think that going forward that it's still a use of our corporate cash flow is to repurchase stock, pay dividends and do acquisitions. So we haven't really changed any of that mantra going forward.

Terrific, very helpful. Nice quarter. Thanks.

Mike Schneider, Robert W. Baird.

Good morning, guys. Another great quarter, congratulations. Focus on contractor for a minute, just your comments about professional and the channel there sounds very strong. Did I hear you correctly, Dave, that the four largest customers within professional were up double digits?

That's correct.

Okay. So roughly what was professional up during the quarter?

It was 17%.

17%, okay. Then that actually implies that the home center channel was down high single digits?

Yes, in fact at a couple of the conferences we all attended in the first quarter, I know a number of you approached us and asked about the Home Depot activity. And obviously we couldn't say anything because we don't provide guidance, but we enjoyed the same phenomenon that most suppliers -- that Home Depot did in the first quarter of the year. January and February were well below where they had been from a purchasing standpoint over the previous years. They basically just shut down the purchase of any inventory. Out the door sales were still strong, but we had situations where we know stores -- we lost sales because there wasn't inventory in the stores. It came back in March of this quarter. March was a very strong month for us, but still wasn't able to recover for the loss that we had in January and February.

Just as I was doing the math, it looks like home center was probably down 14%.

Hold on a second. In fact, That was just about right, Mike.

I try.

Mike, there is a couple of classification issues that are now appearing as reductions in sales that previously were reported as cost of goods sold. Your 14 is correct, but it's -- mathematically it's a little overstating the actual decline in the shipments of units.

What's happened is that Home Depot is now paying their own freight so it comes out the sales line for us whereas before it was in the cost line.

Okay, got it.

Bottom-line it's the same it's just negative on the top.

With contractor up 10% this quarter, do you have a sense as to what units were actually up in contractor? I'm trying to get a sense of how much mix is benefiting you as the commercial side comes back?

We introduced a new GH unit this year which has been very successful but still the entire productline has been very, very strong. Even the entry-level sprayers and professional have been extremely strong this year. So it's not one segment or we can't really identify saying that commercial is really leading the market and actually improving the contractor business. It really is across all productlines.

And Dave, we've been at his for years now trying to call the contractor's mind set. You and I have talked in the past that it's not actual sales that influence these guys’ purchases; it's their perception of the market. So while sales are strong today, as your guys out in the field go to these Expos and demonstrations, is there any -- or what's been the mindset change among the contractors?

Mike, all I can tell you is that every salesperson I talk to is very optimistic about the contractor marketplace. They spend five days a week with those guys. I have heard nothing other than perhaps in the rust belt -- Michigan, Northern Ohio appear to be extremely soft, but every place else in the country is very strong.

And what do you read into then, just switching back to home center, with March being strong is there anything else to read in there other than it was year-end inventory window dressing (multiple speakers) most part?

I don't think so. Home Depot is Home Depot. They have their own mind and they do things generally the way they want to. All I can tell you is out the door sales look very good. It was just another one of those periods we went through when they -- and this was probably one that was more sustained for a longer period of time than others where they reduce their inventory.

And what new products -- you mentioned the GH unit in professional. What other new products have been introduced in contractor this spring?

It was a new line of Ultras that came out in the spring. New textures, in fact we were at an operations review with our contractor folks last week and the texture unit is selling extremely strong in Europe. In fact, even at a higher rate than what we had originally anticipated. So we're getting some very nice growth coming out of the new Mark 5s, the Mark 6s -- or I'm sorry, the Mark 10s in the texture units. And then on the Ultra side it was the 490s, the 495s, the 595s -- all of the entire Ultra line has just been selling very well.

Final question just on Asia, Dave. Now, Last year -- seemingly a disappointment with the decline in sales. You were down 2% in Asia-Pacific this quarter, yet you're indicating clearly in your comments and the press release that bookings have picked up double digit.

The good thing that we see coming out of Asia -- there are two countries that are down, it's Japan and Korea. We think Japan is just the short-term cycle. We had one distributor there that had a huge project last year with one of the Japanese car manufacturers that didn't repeat itself obviously and he's off. But the good news is if I look into China, which was relatively flat last year; China is up in all segments, both the contractor business and the industrial business.

Australia, New Zealand continues to be very strong. India is really -- it's a tiny component of our business today, but the activity there is just incredible. The incoming order rate is almost -- increased by almost 80% over what it was previously. Again, a very small base, but a lot of activity from car transplants, domestic manufacturers of autos and also motorcycle plants in India.

So you expect Asia to be up for the balance of the year given that?

Considering what the backlog is and there would be no reason for us to believe that Asia was going to be down.

Bookings are up there, Mike, it's just the billings aren't, but they'll catch up.

Okay. And speaking of backlog -- sorry, final question -- backlog up $14 million. It's never been a focus for the business, but what is backlog and I'm kind of surprised you call it out this quarter?

We call it out primarily because there was a little bit of backlog in the contractor business this quarter based on what was going on at the Home Depot. They entered some orders right at the end of the month that went into backlog. The backlog in Asia was extremely strong, primarily with our rim product. We're having some very good success with our rim product in Asia on the industrial side. And then basically a smattering of every place with the exception of lubrication. Lube has been able to deliver on their backlog -- or deliver their orders very quickly.

You're right, though, we don't usually call it out, Mike, and it's still only about three weeks of our sales roughly. But it increased so much and it was a pretty important factor with respect to Asia that we felt that we should call it out this quarter so everyone understands that that business really is pretty healthy.

And what is it up in percentage terms, Mark?

About 19% on bookings.

Okay, great. Thanks again, guys.

John Franzreb, Sidoti & Co.

Good morning, guys. Most of my questions have been answered, but looking at the lubrication business and the continued strong topline results that they're posting -- I know that a lot of the auto dealers are suggesting that they're going to aggressively increase the number of days that they use in the service business. Should we be rethinking about the growth outlook in the lube side of the business?

John, obviously we've stated for years that that business should grow at GDP; the last couple of years have been phenomenal. And it really is based on just what you said, the new dealerships that are being built and the number of bays they're putting in. I think it's a -- I don't want to call it a short-term phenomenon because it's been going on for a couple of years, but it could get us through the next couple of years as well just because of the amount of growth in new dealerships that's occurring.

Okay. And secondly, the cost and when do you expect them to hit over the balance of the year? Can you give us any kind of guidance of when you expect to incur the cost for the consolidation?

It's pretty even. We'll be spending as we go. We've got some downsizing costs associated with people in our Spanish operations during the year. The Lakewood facility will be closing at the end of the year and we will have some costs associated with relocating equipment and people and so on during the year. So it will be a little lumpy, but it will occur throughout the year.

Okay. And dose that change your CapEx budget at all or what are we looking at for the full year?

It should be pretty close, about 25 million roughly.

Okay, great. Good quarter, guys. Thank you.

Ned Armstrong, Friedman Billings Ramsay.

Good morning. With regard to your industrial markets, can you just comment on any that were particularly strong or were maybe a little bit less vibrant than the others? Those at the extremes I'd say.

I can tell you that our high-performance coatings and foams, which is our fast-set foam business, is growing beyond what our expectation was. The acquisition of Gusmer couldn't have come at a better time with that market growing the way it is. We've had real good success in that area. As I look across the segments, actually with the exception of our sealants and adhesives business, which is -- probably half of that's related to automotive, everything is up double-digit. Our rim business is up well over 100% compared to last year, so there's good growth in the high-performance coatings and foams which is the fast-set foam business, and our rim business is extremely strong.

Is the performance in that -- the performance in your high-performance foams, is that a byproduct of just strong end markets there or better acceptance of that particular product?

I think it's a combination. There have been a number of studies that have been done over the last year showing the cost benefit of foams in new homes and I think that has driven some activity in that area. The builders associations and so on at trade shows are really emphasizing foams as compared to the normal type of insulation and that's driven the business.

Okay, great. With regard to the tax rate; do you see for the remainder of the year it reverting to the 33% area or do you think it will stay up closer to 35?

I'll let Jim answer that.

I think, Ned, that it will stay closer to the 35. We do have the one wildcard that we're hoping that Congress reinstitutes the R&D credit. If that happens our annual rate will drop about one-half of 1 percentage point. But the other is a transition to this new manufacturing production deduction. And that will stay with us the whole year. It will get better two or three years out, but for the next couple years we will have a higher rate.

Okay, and then just one more. I noticed you had a pretty big jump in the accrued liabilities this quarter. Is that a byproduct of seasonality or is there something more to it than that?

We're all kind of puzzled here.

Maybe I misstated the account name; it was other accrued liabilities.

Jim's taking a look right now, Ned.

I can circle back off line of that's better. I can do that.

Matt Summerville, McDonald Investments.

A couple questions. First, with the recent acquisitions, can you remind us what the kind of margin run rate was in the back half of 2005 for Gusmer and liquid and then where they were in the first quarter?

Matt, we don't break those out. All I can tell you is they were single-digit operating margins when we bought them. We're running in the mid to high 20s and we would expect them to get there by the time we integrate them.

The only thing we did say, Matt, was that they contributed in the fourth quarter to earnings, but prior to that they really were non contributing to earnings because of some of the purchase accounting adjustments that we had made.

Okay. And then for the fast-set foam business, how do you size up that market, Dave? And then you mentioned the growth rates you're seeing in your equipment sales are outpacing your expectations. What had you been expecting and what kind of growth rates are you seeing?

For competitive reasons we normally don't want to break it down by segment like that. I can tell you, Matt, that it's running at mid to lower mid double-digit growth rate. I think that's maybe 10 points higher than we had anticipated originally and I think it's just a matter of more people accepting the materials and the cost of the materials considering what the return on the investment is of using it.

Okay. And then just one final question, just a housekeeping item. Mark, what was the revenue contribution -- well, here's what I'm trying to do. I'm trying to get your core growth rate in the industrial business. You would have had a little bit of left over contribution from the acquisitions. Do you know what that revenue number was?

Well, I think we had one month of Gusmer sales, so it was maybe a couple million bucks, a couple 3 million bucks.

Maybe, Matt, because the first month that we acquired Gusmer they hadn't had a good month.

Okay. And then where are you putting the stock option expenses? Is that falling in the corporate line or is that allocated by business segment?

Part of it's in the operating expenses and part of it's in G&A -- or not in G&A but in cost of goods sold.

To answer your question, Matt, with respect to the segments. It's shown as a corporate expense. The total will be announced, but as Mark said, between cost of goods sold and each of the operating expense categories.

Okay, thank you.

Charlie Brady, Harris Nesbitt.

This is actually [Corey Hinkle] sitting in for Charlie. Thank you for taking my question. Just looking back to your comments you made about your industrial business in Asia, how much of your double-digit booking growth can you attribute to China specifically?

I don't have that data, but I can tell you that China was much stronger this year than it was last is about all I can say about it.

And how is China looking overall just as your company on the whole?

I think we're certainly very pleased with the business there. We're probably one of the few companies that since the time that we've been in China we've been profitable. It continues to be a very good business for us. As you probably know, we're opening a plant there within the next six weeks or so where we'll be doing some assembling of product and shipping it back to Europe and the U.S. initially. So we're very pleased with the China business.

Okay. As far as your industrial business in Europe, where do you see the strength coming from? What do you think is driving the strength there?

Actually it's everywhere with the exception of France this quarter. France was a little light compared to what it had been previously, but every other country in Europe has been extremely strong. Not only Western Europe, but also Central and Eastern Europe. So we're just seeing good growth coming from a variety of different markets in the European economy with the exception of France and France was I think relatively flat this quarter compared to last or first quarter last year.

Okay, perfect. And finally, when do you expect to complete the consolidation in Lakewood? You mentioned that you're going to close the plant, but when do you expect the whole operation to be moved?

We hope to have everything completed sometime this year or very early next. We've announced to our employees that we're moving out and we're expanding our facility in North Canton to move that in. We're really dependent upon how quickly we can get the facility built and ready to go in North Canton and then being able to move those operations. I would hope by the end of this year or very early next year we'd be able to be out of Lakewood.

Great, thank you very much.

(OPERATOR INSTRUCTIONS). Ned Armstrong.

That's okay, my final question has been answered. Thank you.

Okay. Thanks, Ned.

Thank you. Management, I'm showing there are no further questions. I'll turn the conference back to you for any closing comments.

(inaudible) item from Matt with respect to the other liabilities. That is all -- the increase comes from the income taxes. Income tax payable went up $16 million between the end of the year and in the first quarter.

Anyway, let me go ahead and in closing, obviously we're very pleased with the performance of the business -- in fact with all of our businesses in the first quarter. As usual, Graco employees worldwide rose to the task of implementing the acquisitions without taking their eye off the ball for the existing business. They did a very nice job as well in proving the existing businesses.

As we mentioned earlier in the conference call and in the press release, there are going to be costs associated with the integration of the Gusmer operations, but frankly, as we look at the return on investment on those dollars spent, it clearly justifies the expense. We remain optimistic about our business. We continue to watch housing starts, remodeling expenditures, activity at Home Depot very closely. We're reading the same types of publications you are, but we have not seen anything yet that would indicate that the contractor business is showing any signs of slowing.

So with that, I want to thank everybody for participating in the call and, more importantly, I want to thank all the Graco employees for the great job they did this past quarter. Goodbye.

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