Graco Inc (GGG) 2006 Q3 法說會逐字稿

Good morning, and welcome to the third quarter 2006 conference call for Graco, Inc. [Operator Instructions]. At the request of the company, we'll be opening for questions during the question-and-answer session after the opening remarks. 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 Safe Harbor provisions of the Private Securities Litigation Reform Act. Actual results may differ materially from these indicated as a result of various risk factors, including those identified in the Item 1A of Exhibit 99 to the company's 2005 annual report and Form 10K. This report is available in 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. [Operator Instructions].

As a reminder, this conference is being recorded today, Thursday, October 26, 2006. I would now like to turn our conference over to Mark Sheahan, Chief Administrative Officer. Please go ahead, sir.

Thanks, Rose. Good morning, everyone. I'm here today with Dave Roberts, our CEO, and Jim Graner, our CFO, who's going to start off by reviewing some of the highlights of yesterday's release, and then we'll open up the call for your questions.

First of all, we had a good quarter. We had underlying growth in all three of our reportable segments again. This is our eighteenth consecutive quarter where we've had that. We also had 13 consecutive quarters where all three of our segments have reported revenue gains. Sales for the quarter were up 14%. They came in at a record $202 million. Of that, acquisitions contributed three percentage points of the growth. Sales without acquisitions were up about 11%. Growth in the third quarter is really summarized as, again, growth in all three segments. Industrial was up 15%, Contractor was up 4%, and Lubrication was up 65%.

On the net earnings side, our net earnings and diluted earnings per share were up 21% and 23%, respectively. The growth in the third quarter earnings includes stock-based compensation of approximately $1.4 million after tax. For comparison purposes, there were no such expenses in last year's P&L.

Next, I'll touch briefly on the three segments. First of all, Industrial. Their sales were $101 million. They were up 15% this quarter versus last year. In the Americas, sales were up 19%. We saw nice gains in the protective coatings side of the business, the process side of the business, and the finishing side of the business. In Europe, our sales were up 15%, with increases in most of the geographic regions that Europe serves and most of the major product categories there as well. In Asia, our sales were up 4%. We saw nice strength in China and Southeast Asia, and they offset weaker business in Korea and Japan versus last year. Third quarter operating margin for Industrial was 31%, and that's up about 400 basis points from last year. A combination of both higher sales and improved profits from the acquired businesses led to that improvement in the operating margin for Industrial this quarter. In summary, in Industrial we saw nice growth in all three of the regions across the major product categories, sort of a continuation of what we experienced in the first six months of the year.

Next, looking at our Contractor segment, the third quarter sales were $79 million. That's up 4% from a year ago. In the Americas, sales have leveled off, so we're starting to see, likely seeing the impact of some of those slower housing starts in the U.S., but our strong commercial business and the resiliency of the remodeling market is believed to be offsetting some of those results. In Europe, our sales were up nicely, 25%, again experienced good increases in all of the categories and throughout most of the regions that we sell into. The team in Europe is really focused on converting end users, adding new distribution, and successfully launching the new products that we have in the Contractor segment. In Asia, our sales are up 20% off a small base. We're building our brand position there and the awareness for the product lines throughout the Asia-Pacific region. The operating profit margin for CED in the third quarter was 27%. That's 100 basis points higher than last year. We continue to manage the expenses in the CED business very well, and we will do so to support and maintain profitable growth of that business as we move forward.

Next, looking at the Lubrication segment, the sales for the quarter were $22.4 million. That's up 65% from last year. Of that, the Lubriquip acquisition contributed 44 percentage points of that growth. The operating margins in Lubrication, not surprisingly, were down a bit this quarter. They came in at 21%, and that compares to 24% last year. The decline in the operating profit is due to the acquisition of and inclusion of Lubriquip into the business operations this quarter. In the press release, we noted that there were approximately $1.2 million of non-cash charges related to Lubriquip in the quarter, and about $500,000 of that amount is amortization of intangibles, which we'll experience going forward in the coming quarters.

Next, looking at the company's gross profit margins, Graco's gross profit margin was 52.7% for the quarter versus 53.5% last year. Again, the decrease was really due to the acquisition of Lubriquip. We do, in the manufacturing operation, continue to have cost improvements that are--production improvements that are helping to offset some of the material cost increases that we've experienced this year. The year-to-date gross profit margin is 150 basis points higher than last year.

Reviewing our operating expenses for the third quarter, the operating margin was 27.2% compared to 26.5% last year. That's despite an increase in product development spending, the expenses from stock-based compensation, and the expenses associated with the Lubriquip acquisition. In, it was also noted in the press release that we incurred about $1.7 million in the third quarter related to Gusmer activities. These costs were included both in costs of goods sold and operating expenses.

Next, turning to the tax rate in the third quarter, our effective tax rate was 31.4% for the quarter, and it is at 33.9% on a year-to-date basis. The lower effective tax rate in the third quarter resulted from resolution of some prior year income tax audits, expiring statutes of limitations, and higher than expected benefits from the extraterritorial income exclusions and domestic production activity deduction.

Some other items worth noting, year-to-date cash flow for operations was again pretty strong at $117 million. Significant uses of cash this year have included dividends of $30 million, property, plant, and equipment additions of $22 million, share repurchases of $70 million, and acquisitions of $31 million, all for cash.

In summary, Graco had another record quarter. Again, this is our eighteenth consecutive quarter of sales growth versus the prior year, and it's our nineteenth quarter of consecutive net earnings growth. The business was generally strong across all of the segments and the geographies again this quarter, with decent tempo as we head into the fourth quarter. This concludes the prepared remarks, so Rose, if you'd open up the call for questions at this time, we'd be appreciative.

Ladies and gentlemen, at this time we'll begin the question-and-answer session. [Operator Instructions] One moment, please, for our first question. Our first question comes from John Franzreb. Please state your company name followed by your question.

Sidoti and Company. Good morning, guys.

Mark Sheahan and Dave Roberts: Good morning, John.

My first question is regarding the impressive growth in Europe. Could you share a little bit about what the drivers of the growth are and do you have a sense where your kind of market shares stand in Europe?

John, I can talk about where the growth's coming from. It really is basically equally divided between our Contractor business and our Industrial business. The Contractor business is just the effect of our people continuing to convert the folks who are using brush and rollers to spray equipment, and they've just done a very nice job in doing that over the last three or four years, honestly. And then the Industrial business, driven primarily by the expansion of capacity in Eastern Europe. We've said in the past that as our customers move from Western Europe to Eastern Europe, they're putting Graco systems into their factories there. But we've seen some growth, as well, in the traditional manufacturing countries in Europe--France, Germany, a little bit in the U.K., not much there. But the traditional manufacturing companies are growing as well.

Do you have a sense of what your market share is relative to Wagner?

John, I really don't. On a global basis, we think we're probably 60% or so of the entire market, and I would guess that it's probably not quite that large in Europe, but I think we probably have a larger share than Wagner does.

Okay. Second question. In the Industrial market, any concerns, are you hearing anything from your customer base about the consumer durable market and potential weakness in that market?

No, we really haven't. We've been staying very close to it, just trying to understand what's going on, because everything you read appears to be more negative than what we're seeing. And we've not seen anything that indicates that one specific market is slowing down in the Industrial business. We still are getting great orders coming out of agricultural, construction, equipment, the traditional markets. Now, automotive, and when I say "automotive," U.S. automotive is, continues to be very, very soft, but made up by the trans plant as well as the foreign manufacturing auto manufacturing companies around the world. But the U.S. automotive, and primarily Ford and GM, are very soft for us.

Okay, and one last question. It looks like you repurchased another 20-plus million dollars of stock in the quarter. What was the average cost you were buying back stock at?

I'll let Jim answer that here. Is there another question, John, while Jim looks for it?

I'll give it a shot. I was just wondering what the geographic sales mix is in Contractor. If you have that number handy, that would be great.

Yes, we're still, about three-quarters of our sales are still in the U.S. The, and then this is purely guess. I haven't seen it. But it's 16% or 17% is in Europe, and the remainder is in Asia.

Yes, of the $250 million they've reported so far this year, John, about 195 is in the Americas, about 40 is in Europe, and about 15 is in Asia.

Great.

John, back to your other question. Average price in the third quarter was $38.44.

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

Thanks.

Thank you. Our next question comes from Mike Schneider. Please state your company name followed by your question.

Hi. Robert W. Baird. Good morning, guys. I guess we talked about Industrial, so can we focus on Contractor for a minute? Can you just give us a sense, maybe, what the momentum of the Americas business looked like during the quarter, and what you're hearing out of these DIY customers as far as their plans for inventory in the fourth quarter and first quarter?

I guess when you say DIY, meaning home centers?

Yes.

Just to speak about home centers, initially, the out-the-door sales still looks pretty good at home centers. But what they've been doing, what they've been doing at Home Depot, they're now working toward a four-week inventory level in the stores as compared to a six-week, so they've been cutting back in the stores as they've been going. But as we look at the out-the-door sales, Mike, they're still pretty darn good. So I think we're still optimistic about what's happening there, but again, the customer is just adjusting his inventory levels.

If we go to the pro customer, their sales--in fact, our largest pro customers, their sales out the door are still double digit, believe it or not. And now they're a little lower than they were in the first and second quarter, but still very strong. Now, they're being cautious based on what everybody's reading about housing starts, and I think they've been cutting back on some of their purchases, but still at a relatively healthy level. But again, out-the-door sales in our largest Contractor customers is certainly in the low double digits.

And when you, home center sales are still good. Has the rate of sales rate, though, slowed at your home center customers?

I'm not quite sure what you mean by that.

Meaning the out-the-door sales and home center customers. Have they slowed, even though they're still good, in using your words?

You know, it's, there's nothing that you really can distinguish there. I mean, it hasn't gone from 15 to 10, or it might be off a point. But it's not off significantly that we can see, Mike.

So at this point the flat sales in the Americas sounds like it's almost entirely due to just inventory adjustments.

Yes, and it's not just at Home Depot. Our professional customers have been buying less. Yes, I think what they're doing is preparing themselves in case the slowdown hits.

Okay. What are you guys doing to prepare for it as well? Have you changed your marketing strategy, your spending budgets, whatever it is to try and address what might be a slower '07 for the Americas?

Well, the first thing we haven't done is cut back on new product. We continue to invest heavily there. We think that will drive growth for us, particularly since the market is so strong outside of the U.S. We certainly have discretionary budgets that all of the departments are watching very closely. If we really detect a slowdown in incoming order rates, we would be able to put the brakes on from discretionary spending that would be easily to adjust and not have a dramatic impact on the business short term, certainly. But other than that, really, there's nothing else that we've done. We're going through the consolidation of the factories to the acquisitions. We think that will give us some leverage next year as we complete those, but those are really the things that we're focused on.

Okay, and what is the need for margins, then? As we go into '07 for the Contractor division as Europe and Asia continue to grow 20-plus percent, and presumably the American slows down?

Well, I think the margin performance that we have in the other regions are as good as or slightly better than what we have in the U.S., so as that business becomes a larger component of our total sales, it will have a neutral to a positive impact on the margin rates, and I wouldn't see any,--frankly, I haven't looked at any numbers--but I don't think there will be a dramatic impact on margin going forward if the U.S. slows down and the other parts of the world pick up.

Okay, and then just in terms of product placement, either home center or professional, you presumably have gone through your end line reviews now. Have you, or do you plan to introduce any new price points or skews in either of the major Contractor customers in the Americas?

Well, there are again new products that are being introduced every year, and generally, that's the way that we're able to recover some, or increase the price of the units, by doing that. There's nothing, there's nothing that we've done through the negotiations or year-end reviews with our customers that will have a negative impact on pricing or margin of our products.

I'm actually focused on the positive side, though. Have you gained or displaced any other competitive priced--?

No, there's been no change in what the landscape looks like.

Okay. And then, just the Industrial outlook. Again, the question was asked before but maybe in a different way. Obviously, there's a lot of press about the U.S. economic slowdown. Have you seen it, though, in your, either maybe in your pricing discussions with some of the major distributors or contractors that are, I'm sorry, E&Cs of sorts, or have you seen it at all in softer project activity or quote activity? Anything like that or--?

No, the simple answer to that question is no, not yet. Though I mentioned that the U.S. auto companies are relatively soft. In fact, they're beyond relatively soft. We actually saw an increase in our Stevenson adhesives business this quarter, which has been relatively flat for the year, and that's driven usually by some automotive projects. So our Stevenson adhesives business actually got better this quarter, while the other businesses remained relatively at equal levels that they have been all year.

Okay. I'll get back in line. Thanks, guys.

Okay.

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

Thanks. BMO Capital Markets. Good morning, or afternoon, guys. Could you comment on Lubriquip, and acquisition, typical time frame for sort of moving the margins up? Typically you guys have about a 18- to 24-month spread on taking costs out and sort of moving those margins up. Anything unusual about the [inaudible] Lubriquip management's got in house that might change that outlook?

Not, not really. I think we laid out when we bought it that what we'll be doing is closing the Cleveland, Ohio, plant and the Madison, Wisconsin, plant and moving into a facility here. We'll have that done by the end of next year, of 2007. That will have an impact on margin. There are a couple of product lines in that offering that, frankly, don't excite us, and we're going to have to do some things, either from a cost side or a pricing side, that will help margin, and primarily from the cost side. But there's nothing there that we've seen that really is disturbing. In fact, the more we get into it, the more excited we get about it. It's almost like the Gusmer acquisition that we made a year or so ago. You know, the more we learned about it, the more opportunity we saw.

Okay. And just back to your comment about the Home Depot going to four to six weeks. What's your sense on where they are in that process, and at what point do they sort of reseek delivery and when they've gotten to where they want to be in your mind?

I hope I didn't misspeak. They were going from six weeks to four weeks, not the other way.

Sorry, it's my mistake.

Okay. I really can't answer that. My guess is they're pretty much along the way. We would hope that the sales in the fourth quarter will be relatively stable. I think they're pretty much along that path.

Okay. Thanks, guys.

Okay.

Thank you. [Operator Instructions]. Our next question comes from a follow-up from Mike Schneider. Please go ahead.

Hi, guys. Just, Mark, maybe you could clarify on some of the charges that were run through during the quarter. You say in the press release that $1.7 million in costs this quarter, but the Q you also filed last night just says $1 million. Are there different expenses there you're talking about, or is it just decimal point issues?

I'll try to answer that, Mike. The difference in the Q is related to restructuring charges only, basically stay bonuses and stay incentives. The $1.7 million includes some inventory charges that we took as well.

Okay. Okay, thank you. And then also, just on the $4 million to $5 million that you had been estimating in expenses. The Q says you've incurred $2 million to date, even though last quarter we talked, and maybe it's the same issue, but last quarter you mentioned $1.5 million in expenses, and $1.7 million this quarter. Is that the difference, again, between those numbers? It just seems like you've spent more than you stated in the Q.

Yes, it's a little bit of rounding to even millions, so it's exactly what you talked about, with some rounding going different ways in different periods of time.

Okay. And the payback from these facility moves and consolidations. Is $5 million a rough run rate you expect to achieve from these, presumably at some point starting in '07?

Probably, certainly in '07 for the Gusmer acquisition, but it would be 2008 for Lubriquip.

Okay, fair enough. And then, what expenses should we be modeling now going forward? We have the Gusmer expenses will presumably end here in the fourth quarter, and that's the remaining portion of the $5 million you've mentioned in the past. What should we be banking in for Lubriquip aside from the million you spent this quarter?

The Lubriquip spending, Mike, has not really started. There will be a total of $2 million. We'll have to incur about $500,000 of that in the fourth quarter and $1.5 million over the first three quarters of 2007.

Okay.

The Gusmer wind-up will happen in the fourth quarter with a few hundred thousand slipping into the first quarter of '07.

Okay. What else? And then, I'm sorry, I must have a different map working here. But how much did you actually repurchase in dollars in shares this quarter?

$24 million.

Okay, all right. That's it. Thank you.

Okay, Mike.

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

This is Ned Armstrong with FBR. Good morning, everybody. You mentioned in your press release that you had seen on the Contractor side strength in commercial construction. Traditionally, you've been able to track that by the type of product or model of product that you're selling. Is that still the way you do it, or is, have you discovered a way to better track the demand from that particular market?

No, no new magic, Ned. It's primarily looking at the higher volume sprayers that are selling, and that's what we're seeing is strength in that area. But again, we've always said that our contractors, they don't care what it is, they're going to paint it. And if a job becomes available, they'll be out there bidding on it. And really, what we've, I mean, we're just going by what we're selling in the high-volume units plus what we're reading in the press, is that commercial should be strong this year and next year.

Okay. And is that commercial strength that you're seeing, based on what you're selling, coming from both the U.S. and overseas markets, or is it predominantly U.S.?

Predominantly U.S. The European marketplace is still not a high-volume market at this point. It's generally our medium-duty sprayers, along with texture. We're selling a lot of texture units in Europe.

And is that, the fact that it's not a high-volume market, is that more of a cultural thing as you alluded to before, or is there, is there someone else there with a presence that you haven't been able to penetrate yet?

No, it's just a matter of their buildings are generally smaller. They just, they're still making that transition to spray equipment. There's nobody there that we're concerned with.

Okay. And then with regard to Lubriquip, can you talk about any potential for international opportunities there? What you can build on or what you can exploit?

There's no question there's opportunity there. Ninety percent of their revenue is generated in North America, and one of the opportunities we saw was the fact that we could expand that into certainly the other areas of the world. Pat McHale, the VP who's in charge of that division, has spent the last two weeks or so visiting with distributors in Europe, primarily, and then we'll be going on to Asia to visit with those as well. So we think there's some opportunity to grow Lubriquip outside of North America.

And that's your existing distributor base that you're speaking to, that Pat McHale spoke to?

No, no, these are distributors--yes, existing Lubriquip distributors that, frankly, I think, have suffered from the lack of new products and innovation in that product line over the last number of years. And he's out trying to get a sense for what the market needs, what the distributors need, to grow their business, and that's primarily what he's doing.

And we do have a handful of existing Graco distributors that would like to get the product line as well.

Right. Okay, good. Thank you.

Thank you. And gentlemen, there are no further audio questions at this time. Please continue.

Okay, well, I'd to thank everybody for attending the conference call. I think Mark said it best in his opening remarks, that we had another great quarter. We will continue to be cautious in the news that we hear and we read, but frankly, we just have not seen it in our business yet, so we're still optimistic about this being a very good year for Graco. So with that, again, thank you all, and we'll look for you next quarter.

Thank you. Ladies and gentlemen, this does conclude our conference. You may now disconnect. Thank you for your participation, and please have a pleasant day.