Graco Inc (GGG) 2006 Q4 法說會逐字稿

Good morning and welcome to the fourth quarter year end 2006 conference call for Graco, Inc. If you wish to access the 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 is 11081328. The replay will be available through February 2, 2007. 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 may be made by management about their expectations, plans and prospects for the future. These remarks constitute forward-looking statements for the purpose of the Safe Harbor provisions 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 1A of and Exhibit 99 to the Company's 2005 annual report on Form 10-K. This report is available on the Company's Web site, at www.Graco.com, and the SEC's Web site, 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). I'd like to remind everyone that this conference is being recorded today, Tuesday, January 30, 2007. I would now like to turn the conference over to Mark Sheahan, Chief Administrative Officer.

Good morning. I'm here this morning with Dave Roberts and Jim Graner. We've got a couple of opening comments to make, and then we'll open it up for your questions.

First of all, the quarter -- the fourth quarter was a good quarter for Graco. We had 10% topline growth, with 18 quarters in a row now where we've had sales growth when you compare to the previous year. Our sales for the quarter came in at $203 million. When you cut through, the acquisitions and favorable exchange rates contributed about 5 percentage points of the growth in the quarter.

To look at the segments just quickly, the industrial sales were up 14% in the quarter -- they were up 11% with constant exchange rates -- the contractor sales were down 2%, and lubrication sales were up 40%.

For the quarter, net earnings and diluted earnings per share were up 10% and 12%, respectively. For the year, Graco had consolidated revenue growth of 12%. Industrial was up 13%, contractor was up 5, and lubrication was up 34. For the year, our net earnings and earnings per share were up 19% and 21%, respectively, and that makes it our fifth consecutive year of record results.

I'll just talk briefly about each of the segments, starting with industrial. For the fourth quarter their sales came in at $111 million. That was a 14% increase. With constant exchange rates, sales were up 11%. And then, by geography, the industrial sales in the Americas, Europe and Asia were up 9%, 17% and 23%, respectively. The operating margin came in at 29.5% of sales, which was an improvement versus last year's fourth quarter, which was at 28.8%. To summarize industrial, we continued to see nice growth here. We had double-digit growth in the segment, with gains really coming from all three of the regions and across the majority of the product categories.

Turning next to the contractor segment, the fourth-quarter sales were $71 million. That was a 2% decline from last year's fourth quarter. In the Americas, sales were down 11% -- clearly, seeing some impact from the softer housing market in the U.S. But, our strong commercial construction business, as well as pretty good international sales and decent remodeling activity [we] believed to help the results on an overall basis for the quarter. Sales in Europe were up 30%. We had increases in all product categories and throughout all the regions in Europe. In Asia we had a 21% increase in contractor. Again, it's off a pretty small base there, but we're building product awareness throughout the region, and those results are starting to contribute to the overall contractor sales and profitability.

Despite the overall sales decline in contractor, our operating margins in the fourth quarter actually increased to 24.4%, versus 23.9% last year. And the main reason for the increase is the favorable product mix in the quarter, particularly the nice growth that we saw at the international side of the business. Going into 2007 we're going to continue to manage the expenses of the contractor business to support (indiscernible) the profitability as we move forward.

Next, looking at the lubrication segment, the fourth-quarter sales in lubrication were 21.8 million. That's a 40% increase from last year. Acquired businesses -- the Lubriquip acquisition contributed 35 percentage points of that growth. The operating margin was 21.9% in the quarter versus 26.4% last year. The decline in operating profit was attributed to the Lubriquip acquisition being included in this quarter's results.

Next, looking on an overall basis at Graco's gross profit margin, for the year our gross profit margin was 53.2%. That's up from 51.8% last year. A substantial portion of the increase here can be attributed to last year's gross profit margin being reduced by the higher inventory costs of the acquired businesses we had in 2005. The remaining portion of the increase in margin this year came from improved manufacturing efficiencies and higher sales volume, which more than offset the negative impact that we're experiencing from higher material costs in our factories. The fourth quarter gross profit margin was 52.7%, versus 52% last year. Again, some of that was due to higher volumes and exchange.

Reviewing the operating expenses for the year, Graco's operating profit margin was 27.7%, versus 26.1% last year. The 2006 operating profit margin was reduced by 30 basis points as a result of the Lubriquip acquisition. The increase in operating profitability for the year was due to a combination of the aforementioned gross profits being higher, and disciplined spending, which led to lower operating expenses expressed as a percentage of sales. The fourth-quarter operating profit margin of 25.8% was 40 basis points lower than last year due to the impact of the Lubriquip acquisition.

It was also noted in the earnings release that included in our cost of goods sold and operating expenses were costs and inventory charges related to the Gusmer consolidation activities that totaled $4.8 million for the year, and that included 1.6 million in the fourth quarter. The fourth quarter also included about $0.5 million of costs and expenses related to the Lubriquip consolidation activities.

Our tax rate for the quarter -- I'm sorry. Our tax rate -- effective rate for the year was 33.2%, and it was 31.1% in the fourth quarter. The lower effective tax rate in the fourth quarter resulted mainly from the tax legislation reinstating the research and development credit for the full year. That legislation came through in the fourth quarter, so we're able to recognize that benefit. The effective tax rate for next year is anticipated to be somewhere in the 34.5% range.

Some other items -- year-to-date cash flow from operations was $156 million. Noted in the cash flow statement this year, we did add to our inventory as the result of a number of factors, including the Lubriquip acquisition, the addition of our new factory in Suzhou, China, the overall increase in our revenue, and some of the consolidation of the Gusmer operations, which required some additional inventory build to facilitate those moves.

Uses of cash in the year included dividends of $39 million, plant, property and equipment additions of $34 million, $88 million of share repurchases, and the $31 million cash acquisition of Lubriquip. Looking forward into 2007, Graco expects that we will spend approximately $45 million on capital expenditures.

To summarize, we had another good quarter. It's our 19th consecutive quarter of sales growth versus the prior year, and it's our 20th quarter of consecutive net earnings growth. As we said in the release, heading into 2007, we are planning for higher sales and net earnings next year, or this year. So, with that, [Heidi], I'll ask you to open up the call for questions.

Michael Schneider, Robert W. Baird.

Maybe we can focus first -- and I apologize for bouncing around -- on the industrial segment. Organic growth 9% in U.S. industrial. Can you give us a sense of what the trend has been as of late, and if indeed you've felt what is, I guess, an anticipated slowdown here in the U.S. in the industrial segment?

You're asking about historical investor growth?

Just through the fourth quarter and what you've seen thus far, what does the trend line look like?

Just in general terms, the investor business still looks pretty strong for us. We've got a few spots of weakness, I think our traditional sealants and adhesives business, which supports auto and window manufacture and those things, has been relatively flat. But the other businesses have appeared to remain strong and growing healthily. The finishing business appears to be good and the other businesses appear to be fairly strong.

And then, in Europe, 17% growth. I highly doubt the market has grown probably even half that rate. Can you describe what's driving that growth?

It's basically the same thing we've seen for the year. There's still nice growth going on into Eastern Europe. Our Middle East business is still strong, primary protective coatings business that we [sell] down there. But it's just a general overall healthy economy, driven primarily by new capacity being put into Eastern Europe.

How about Continental Europe, that is, Western Europe? Have you seen improvement in conditions in France, Italy, Germany, etcetera?

We didn't see the slowdown that most everyone did, so it's been relatively a predictable growth rate, I guess you could say, out of Western Europe. We see growth in the area of 2 or 3 or 4% in those countries.

And, I guess, along those lines of not seeing the slowdown, presumably you've been gaining share in this slower period in Europe, given your high single-digit growth rates. Do you have any sense or can you quantify kind of where you are in your initiatives to gain share? And that is, when do you revert back to kind of the market growth rate? And I'm presuming you're adding distributors, you're adding product lines. If you can give us a sense of kind of where you are in this growth initiative.

You know, like the baseball analogy, I think we're still in the middle innings. There's still growth that's occurring primarily in Eastern Europe. We're still capitalizing on what growth is in -- is available to us in Western Europe. I think there's still room to continue to grow at these rates in Europe over the next year or so.

And pricing in the industrial segment -- have you put anything through in fourth quarter or first quarter that would be showing in the numbers, or would be showing in the numbers (multiple speakers)

There's no price in the fourth quarter at all. We had some price increases that -- that will be divisionally that will take place during the first quarter. Each division is different, (indiscernible) prices. But starting in January through, generally, the end of February or into March.

And some rough ranges of quantity, low single-digits?

I think we're going to end up probably in the same effective price range that we have over the past couple years. Maybe 2 percentage points.

Final question, just on contractor. Can you give us a sense -- the Americas were down 11%. But how does the home center channel compare to the professional channel?

Home center was down more dramatically than what the paint channel was. I really wish I had a good read on home center. We've talked about it in previous calls. We don't see anything there generically that would suggest that that market is any softer than what -- what the sales are predicting. I think Depot is still working their inventories, and I think that's driving the results more than out-the-door sales for them.

So, home center was down at a greater rate than what the paint stores were. Paint store business really seemed to hit a wall in about mid-November of last year. And from mid-November on, it was just very, very weak in those areas. What we generally would get out of the paint centers toward the end of the year would be some program buying (indiscernible) and so on, and we didn't see that this year as we normally do.

We should have pretty easy comps in the first quarter in home center, Mike. If you remember last year in the first quarter, they didn't do a lot of ordering. They kind of shut off the ordering for pretty much everybody. So, in terms of the comps, the first quarter should be pretty decent in the home center.

So, when you look into '07, guys, what are your expectations for growth in contractor?

We don't provide guidance. We think that there's still some upside. We think Europe and Asia are still going to be very good markets for us. Europe has just done a great job there. We think those should be able to offset some of the weakness in the paint channel business. To me, the wild-card is the Depot business. I'm not quite sure what's going to happen there. But as Mark said, the comparison in the first quarter should be relatively easy. That's about all I can say.

Do you think the Americas for you are flat, up or down in 2007 in contractor?

I think certainly, if you look at the projections for housing starts, I think we'll have a soft first half of the year in the paint channel.

Robert Lagaipa, CIBC.

Just a few questions. One, just to follow up on contractor. Inventories in the channel overall, not just specifically Home Depot, but just the inventories that are out there amongst the distributors that you use -- can you just comment on where do you think they stand now versus several months ago, or even last year? And have you seen, moving into the early part of '07, any change from what you saw exiting the fourth quarter? You mentioned to an earlier question that you saw some weakness from mid-November on. Has that weakness abated moving into '07, or has there been any change there?

I think that we're in pretty good shape when it comes to the amount of inventory in stores. I don't think there's a lot of inventory sitting out there that needs to be sold. I think the paint channel reacted very quickly to what they perceived as a potential slowing in the housing starts. And I think they slowed their ordering down, as I said, toward the latter part of the fourth quarter. I don't think we'll have a lot of inventory to work off when we start to see housing starts to increase. And that's about all I can say about it.

And then, with regard to Home Depot, given the change of leadership there -- I know it's early -- have they given you any indication as to any changes in their strategy and how they deal with you? Obviously, over the course of 2006 they've been drawing down their inventories fairly aggressively. But I've got to imagine that there's an end point there. Given the change of leadership, I'm not sure that changes. Can you maybe provide any color there?

Actually, no, other than what Mark had said earlier. The comparison is going to be easy in the first quarter. We have not had any detailed conversation with, certainly, upper levels of management at Depot that would suggest that their inventory buying policies are going to be different. But our frustration is you walk in the stores, and there are stores that are out of inventory. They have some sprayers, but they don't have all the range of sprayers. And I think they're going to have to react to that at some time. Particularly as the spring months approach and we start to see moving into the summer months, I think they've got to get inventory back in the stores.

Second question is just, obviously, you're in the midst of a variety of consolidations, both in the industrial segment, and then also in the lubrication segment. Can you just comment on how those are going so far? Are they on track? When should we start to see the margin improvement (1) from the volume increases going through fewer facilities, but also the lack of restructuring costs in both segments?

I think that if you look at the acquisitions that we made in '05 -- the Gusmer acquisition and the Liquid Control acquisition -- we moved out of the Lakewood, New Jersey facility at the end of December, so that is now a non-functioning manufacturing facility that we're turning over -- or turning back to the previous owner, which will occur some time in the next couple of months or so. We're just cleaning up, doing the things that were necessary to turn it back over. So, I think, the integration of Gusmer is complete. The integration of Liquid Control is complete.

As you probably know, we expanded the plant in North Canton, where we moved our rim product manufacturing out of Lakeland, New Jersey into North Canton. That is up and running now. The other products were moved in either our Minneapolis facility or our Sioux Falls facility. So, that's progressing. We're certainly well on the tail-end of that integration. There's, as I said, maybe a little bit of cost in the first quarter, but not a lot.

The other one is the Lubriquip acquisition. We have our plant nearly ready in Anoka, Minnesota. We will begin -- in fact, we have some machinery that's moving in this week out of the Madison, Wisconsin facility and out of the Cleveland, Ohio facility. And our intent is to have the Madison, Wisconsin facility -- and this was a Lubriquip facility that we bought -- we'll be out of that by the mid part of the second quarter, and then we'll be out of Cleveland probably at the end of the third quarter, early fourth quarter, and those operations will be closed at that time. We still have a lot of activity that has to take place with the Lubriquip integration over the next 12 months.

So should I take it, Dave, that you're expecting some incremental margin improvements throughout the year, but the largest benefit late in the year into '08? Would that be accurate?

I think so. If you look at the Lubriquip business, we've seen some margin improvement already in that business. But the vast majority is going to come, obviously, as a result of the integration. I think if you were to -- were able to look at the margin performance on the Gusmer and Liquid Control businesses, there has been margin improvement in those businesses already. But the vast majority, you will see it at the end of 2007 going into 2008.

Matt Summerville, KeyBanc.

Just to follow up on pricing, was that 2 points for the Company overall or one of your divisions, Dave?

That would be on average for the Company, about 2 percentage points.

And then you mentioned some actions with respect to Lubriquip on the integration front that will continue into '07. Either Mark or Dave, do you have a number to quantify what those expenses are going to be, and kind of the timing on how we should think about those hitting the P&L as we go through the year?

They're about 2.5 million for the year, and about 600,000 -- 500,000 to 600,000 in the first quarter. The rest will come the rest of the year.

Is there anything left over at all with Gusmer and Liquid, or are the integration expenses completely done at this point?

(multiple speakers) go ahead, Jim.

There's a few hundred thousand of that to come in the first quarter, and then that should wind up.

Is it fair to say, then, Dave, that the conclusion with Home Depot is that sell-through was considerably stronger than your sell-in because of what they were doing with inventories, and, as you sit here today, you feel better about their inventory situation?

Well, what I can tell from the information we've gotten on same-store sales out of our departments, they look -- they're not as strong as they were a year ago, but they're still stronger than what -- the amount of inventory they're buying from us. Let's put it that way. And like I said, they've got to put inventory in those stores at some time.

For 2006, how much of your contractor business was international versus domestic? Was it like 20, 25%?

About 25%, I believe.

Charles Brady, BMO Capital Markets.

Just going back to the commentary on the European growth, your comments were on the industrial segment specifically, correct?

Yes. When I was speaking to Mike, it was primarily industrial. Correct.

Talk then just about contractor, with the sales there up 30% in Europe, sort of really what's driving that business? Is it -- has there been a greater material shift to spray versus paint or roller, or is it really coming out of market share gains on contractor specifically?

It's a combination of that. I think the vast majority is being driven by the conversion from brush and roller. Where last year we saw most of our growth coming out of Southern Europe, we're starting to see it come out of Northern Europe and Scandinavian now, which, you know, the Southern portion is still growing. We've now got the Northern portion growing, which is really a good dynamic to have, and that's the reason we're up 30%. Again, it's a combination of market share gain along with conversion from brush and roller.

What do you think the percentage breakdown between spray, brush and roller in Europe, and is there a big difference between Southern and Northern Europe?

I don't know those numbers offhand. Yes, there is a -- today there is a major difference. And when I say Southern Europe, primarily in through Spain and Italy is where they were -- the vast majority of it was being used with spray. My guess is it's still a higher usage in the Southern portion of the continent as compared to the Northern portion, but it's starting to change in the Northern section. The other thing that has helped us in contractor has been the new texture units that we've rolled out there over the last couple of years as well. So, we've gotten traction from converting brush and roller, and then the new texture units have helped us in Europe.

On contractor in Asia, have you held any additional sort of mini trade shows or meetings, to where you're putting the equipment actually in the hands of the customers who will be using it, to sort of get them to touch and feel it and see how it works?

Yes. That's our -- basically our main strategy in Asia is we have those constantly going on in Asia. So they're -- I've mentioned it before. We go to a major city. We'll rent a hotel. We'll invite the contractors from a geographic region in and put sprayers in their hands. And we constantly do that. We have a few other things that we're going to do this year that, frankly, I just can't talk about yet, which will also help us with that conversion, or more of a knowledge base to help us with conversion.

Ned Borland, Next Generation Equity Research.

Contractor has been mostly covered; most of my questions have been answered on that. But I want to shift over to lubrication for a bit. It looks like the organic sales rate kind of decelerated a bit sequentially. Could you talk about what happened there?

I think our organic growth in lube was up 5% in the quarter. It slowed a bit; nothing that would concern us. I think we had some tough comparisons in the quarter. But also, we had some of the new [dealerships] just -- just wasn't in the buying cycle, I guess, in the quarter. And I don't see anything that's changed there that would be a major concern for us.

And then, shifting over to Asia for a second here, on the new facility, how much has that contributed to your sales growth over there?

Very little. That really -- the vast majority of the product that's being produced in Suzhou is being shipped back to the U.S. for distribution, primarily in North America. It's our auto refinish product and our lubrication product, and those are basically North American businesses.

Jack Kelly, Goldman Sachs.

Just in coming back to the contractor, maybe you could just put this in perspective for us. Clearly, the sales decelerated in the fourth quarter. So what you're saying is that on the Home Depot side, so the Magnum line, that the consumer takeaway in the fourth quarter for Magnum -- was that a positive or negative number, and was it worse or better than in the third quarter? And then, looking at the paint stores, obviously, you mentioned that deteriorated later in the quarter. But could you just give us some frame of reference in terms of percentage changes?

In each of the segments, the out-the-door sales are still positive. If you look at the Depot business, and it has [slowed] as you've gone into the latter part of the year, I'm not sure if it's availability of product or people not buying, if you understand (multiple speakers) talking about.

In the paint store, I think, clearly it's a factor of there has been some slowing there; the out-the-door sales are down, but not down dramatically. But I think it was really driven by our customer adjusting their inventory in the stores to make sure they weren't sitting with a tremendous amount of inventory that needs to be sold if the market -- the bottom just fell out of the market. So, I think, it was good management in the paint store channel, and I'm not sure what it was in the home center channel.

So, in Home Depot, the takeaway is still positive, so the inventory [drawer] down is still going on, which was your point, that in some stores there isn't (multiple speakers)

I think that what Mark had said earlier, I think that our first-quarter comparisons will be relatively easy. We still expect some growth out of the home center and the paint channel this year.

But in the paint channel in the quarter, takeaway was negative or positive?

Positive.

Secondly, just on the lube area, I think you had mentioned, Mark, ex-acquisitions, margin were flat -- is that correct? -- in the fourth quarter.

They were probably up a little bit, Jack (multiple speakers) deterioration came from the acquisition impact.

The margins, Jack, if I recall -- I think the margins were up about a half a point in the quarter. And the vast majority of it was the -- the decline was the fact -- the Lubriquip acquisition.

Based on your earlier comments for the full year, since some of these integration savings don't hit until the end of the year, we should still expect a drag from acquisitions in that sector in '07?

I think that if you look at the margin year-on-year comparisons, they will be down in lube just because of the acquisition.

Okay. Just coming back -- and maybe this ties back to the spray discussion -- inventories were about $76 million, up a lot from last year, but that was because of the acquisitions, but kind of flattish with the third quarter. And typically, it seems like, on a seasonal basis inventories go down in the fourth quarter. So really the thrust of the question is if we look at 76.3 million in inventories, in an ideal world what should that number be? How much of the sprayer stuff might be in there?

I think at the given ongoing sales rate that we have, the growth in the sales rate, I think you'll see inventories come down maybe $4 million to $6 million, primarily because we've built some inventory to help us with the transition of closing facilities and moving into new facilities. We picked up inventory in Lubriquip. Frankly, we built inventory there, because [they] weren't delivering to customers the way Graco was delivering to them. We had some inventory that we added as a result of the new China plant, so now we've got inventory on the water, so we've got more inventory there. And then the remainder was preparing for the move.

Last question. CapEx, at least percentage-wise, moving up pretty substantially. Any one area that's going to take the majority of that increment, meaning the 45 million versus 33 last year?

I think that the vast majority of that is going to go in -- it's actually going to all of our plants. We made some commitments on new equipment in the latter part of this year, which will be delivered next year, and it will go into our -- basically every one of our factories. The vast majority, though, going into the new plant in Anoka.

Ian Fleischer, Friedman Billings Ramsey.

Could you just touch on acquisitions for a bit, how that looks possibly for this year, or other uses for excess cash?

Sure. Obviously, we can't talk about any activity we have underway. But I think the market remains -- the activity remains about the same as it has over the last couple of years. So, that's about all I can tell you on the acquisition trail. The use of cash is what it has been. If we aren't making acquisitions, we're going to be buying back our shares. And we still have our target of 30% of our net earnings being paid out in dividends.

Is there any particular geographic area where you're seeing more acquisition activity than others?

No, I don't think so. It's about the same as what we've seen.

Any particular area within your segments that you're seeing more acquisition opportunities, or you would like to see more acquisition opportunities?

We've said all long that our focus is in the industrial area. We'll be opportunistic in both contractor and lube. But where we [beat the bush] is primarily in the industrial area.

(OPERATOR INSTRUCTIONS). There are no further questions. I would now like to turn the conference back over to Dave Roberts. Please go ahead.

First of all I'd like to thank everybody for attending the call. We're still, obviously, optimistic about 2007. Coming into this year, we've got great momentum coming out of last, with the exception of the slowdown in the contractor business. But frankly, we will have (technical difficulty) sales growth this year. So again, thanks, everybody, for attending, and we look forward to our first quarter 2007 conference call.

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