Graco Inc (GGG) 2007 Q1 法說會逐字稿

Good morning, ladies and gentleman. Thank you for standing by and welcome to the first quarter 2007 conference call for Graco, Inc. If you wish to access the replay for this call you may do so by dialing 1800-379-7444 within the United States or Canada. The dial-in number for international callers is 303-590-3000. The conference ID number is 11087509. The replay will be available through April 28, 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 expectation, 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 those indicated as a result of various risk factors, including those identified in Item 1A of and Exhibit 99 to the Company's 2006 annual report on Form 10-K. This report is available on the Company's Website, at www.Graco.com, as well as 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.

During today's presentation, all parties will be in a listen-only mode. As a reminder, this conference is being recorded today, Wednesday, the 25th of April, 2007. I would now like to turn the conference over to Mr. Mark Sheahan, Chief Administration Officer. Please go ahead.

Good morning. I'm here this morning with Dave Roberts and Jim Graner to talk about our first quarter results. We'll start out by hitting some of the highlights from yesterday afternoon's press release and then we'll open up the call for your questions. Overall, our revenue increased this quarter due to the result of a combination of very strong international sales, the impact of our Lubriquip acquisition, and favorable currency translations. And those were enough to offset the lower sales reported in the Americas this quarter.

On an overall basis, our sales are up 3% with the impact of the Lubriquip acquisition and foreign currency translations adding a combined 5 percentage points to this quarter's sales growth. In Europe, our sales were up 25%, Asia they were up 35%, and again that helped to offset the overall 9% decline in our American sales. If you look at the Americas, the decline was really driven by lower contractor and industrial sales. Our contractor sales were down 15% in the quarter, and our industrial sales were down 11%.

Lubrication sales were higher in the Americas, and that was really driven by the impact of the Lubriquip acquisition. Our gross profit margin in the quarter was 53.1% compared to 53.7% last year. The decline was really driven by the impact of the Lubriquip acquisition, lower product margins, as well as some of the consolidation expenses there.

Our operating profit margin was 26.4% for the first quarter compared to 28.4% last year. Our operating expenses included some additional investments in new products and marketing. Contractor segment in particular incurred about $1 million of expenses related to the start of the new product line of Magnum sprayers that are being test marketed at Home Depot.

The combination of the higher product development spending plus the impact of the Lubriquip acquisition led to the decline in the operating profit margin in the quarter. If you look at our general and administrative expenses they are $15 million, which is consistent with what we've been running at the last few quarters here. Our total operating expenses for the quarter were $52.8 million up about $4.2 million from last year in the first quarter. Some of the major items again were the million dollars of incremental product development spending, the million dollars of incremental Lubriquip operating expenses, about $800,000 of additional amortization expense versus last year's first quarter, and about $800,000 of additional expenses due to foreign currency translations in our foreign operations.

As we noted our backlogs are at about the same level as they were last year at $14 million. The Lubriquip portion of that is about $1.3. Also as we noted the consolidation of our Gusmer operation was completed in the first quarter. And we are actually on track, maybe slightly ahead, when it comes to the consolidation of Lubriquip.

Next, I'll talk briefly about each of our three segments and how they performed in the first quarter, starting with industrial the first quarter sales were $105.1 million up about 5% from last year. If you translated those at the same exchange rates the sales were up about 3%. When looking geographically, in the Americas industrial sales were down 11%, in Europe they were up 16%, and in Asia they were up 42%. The operating profit margin in industrial improved in the first quarter, it was at 32.8%, which was up from 32% last year, and that was really driven by the higher sales.

Well, sales in the Americas were disappointing for us this quarter. We were somewhat encouraged by an improvement in our bookings in the month of March. We saw a slight pick up there and we actually booked a little bit more than we did a year ago in the month of March. However, we were -- as we said in the announcement, we are taking a cautious approach here, before concluding, ultimately where the industrial sales are going to go.

We looked next at our contractors segment. Comparing it to last year's first quarter our sales of 69.8 million were down 6%. Again, it's sort of a mixed bag here. The Americas were down but the foreign, particularly Europe, was very strong, helped to offset some of that. The Americas were 15% lower than last year's record results. We did experience growth in the home centre as we expected. However, it was not enough to offset the decline in the professional paint store channel.

Europe continues to be very strong. Sales were up 40% in the quarter. And we really saw a growth in all of the geographic regions throughout Europe. Eastern Europe, Western Europe, Middle East were all growing in the first quarter. In Asia, our sales were down slightly, I think 3%, but it is off a pretty small base. So, overall we feel pretty good about the health of the international side of the contractor business.

Our operating margins in the first quarter were 24.4%, down from 28.3% last year, which again was a record year for us. A record quarter I should say. The decline in the contractor profitability this quarter was really due to the lower sales in North America and particularly the professional paint stores side. As well as some of the spending that we talked about for the Magnum tests that we were doing at Home Depot.

Lastly, looking at lubrication. For the first quarter, sales in this segment were $22.7 million that was up 28% from last year. That was really driven by the Lubriquip acquisition, which contributed about 33% percentage points of the overall growth. The operating margin for lube in the first quarter was 13.5% compared to again a record 26.9% last year in the first quarter. The decrease in the margin this quarter was really entirely due to the impact of Lubriquip consolidation efforts there as well as the lower gross margins that those products carry.

Couple of other comments. The tax rate in the quarter was 35% that is equal to what we had last year in the first quarter. And again, as we said at the -- in the fourth quarter at our conference call, we were expecting an overall rate of about 34.5% for the year, in 2007. Unallocated corporate expenses were 2.4 million in the first quarter that was really all stock-based compensation expense of about 2.2 million of the 2.4 was stock-based compensation. And that is similar to what we experienced last year in the first quarter.

Currencies added about 3.5 million to our topline and about 1.4 million to our net earnings. That was really driven by the Euro, which traded at an average exchange rate of $1.31 in the first quarter of '07 versus $1.20 last year.

Our inventory and that was up $11 million from the end of 2006. This really reflected the higher level of our international business. We have a longer supply chain associated with supplying our foreign subsidiaries and supporting their sales efforts. In addition to that we also have always experienced a seasonal build of inventory in the first quarter for our contractor business. And in this quarter we also had a number of new products that are being launched in contractor that required additional inventory.

In particular, contractors launching products that don't replace existing products would actually add to the breadth of their product line. A couple of those are our new line of FinishPro paint sprayers, which are air assisted, airless sprayers that the contractor can use to apply things like stains and varnishes. And then he can also flip a switch and it becomes a normal airless spray unit. So, a neat product, it's an addition to the product line.

We also have a new gas hydraulic unit that is targeted at the entry-level contractor, it is our GH 130. In addition, we have a new texture unit, which is an entry-level unit that is targeted at the handyman who already owns an air compressor. He can connect this unit to his existing air compressor and away he goes. He doesn't need to buy a unit that has a compressor with it.

And then lastly, we are testing a brand new line of Magnum sprayers at Home Depot stores. I think we have about 180 stores that we are currently testing and that is about seven new products there that we launched in those stores. So, some of the reason for the increase in inventory this quarter.

Our receivables in the quarter were also up about 8 million. That really reflects the higher sales that we experienced in the latter half of the quarter. Our amortization expense was $2.1 million for the quarter. Depreciation expense was $4.8 million. Our cash from operations during the quarter and our short-term borrowings were really used to buy about 600,000 shares of our stock for $24 million. We also added about $13 million of plant, property and equipment. And we paid our shareholders $11 million of dividends. At the end of the quarter, our cash was about $5 million. And we had debt of about $33 million on the balance sheet.

That concludes -- I'm sorry -- couple of other closing comments here. We did experience slower than expected sales in the Americas but our international business was strong. Our sales in Europe were up nicely. And our order rates were really, really good throughout the quarter and they finished strong as we concluded the quarter. We were somewhat encouraged by the pickup in our bookings in March in the industrial segment. Again, we are taking a cautious approach there. With respect to contractor, as we expected, the professional side of the business remains soft in the Americas but Europe business is very good and we expect that Asia is going to contribute here as well as we work our way through the year.

Lastly and importantly, we are on track to complete our integration efforts at Lubriquip. They did result in a drop off here in the first quarter in our profit margin both for the Company as a whole as well as that segment. But we are taking the right steps there and as we work through those issues those margins will both come up. That concludes the opening remarks we will open up the call now, Michael, for our participants and their questions.

All right thank you sir. The question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS) Our first question comes from John Franzreb of Sidoti and Company. Please go ahead.

Good morning Mark and Dave how are you doing today?

Great John.

My first question is -- I want to get some color from you guys on what your perception is at the inventory level in the DIY, do-it-yourself and the professional paint channels? Can you give us some color of what your customer's inventory levels are like at maybe to a year ago or even six months ago?

John probably -- starting with your first question, it was on the home centre. We know that the inventory levels are better in stores today than they were mid part of last year in the Home Depot stores in -- they bought a significant amount of product in the first quarter from us. So, that certainly helped. If you look at the professional paint stores, we know that their out-the-door sales are actually greater than the amount they are buying from us. So, the -- what they are doing, I think, is being very cautious. They are working their inventories, getting them down to a bare minimum. And even though their out-the-door sales are higher than what they are buying from us, I think they are trying to control their inventory. So, I think the inventory in the stores today is lower than what it was certainly last year at this time, and probably lower than what it was certainly in the mid part of last year.

Now, I guess the next question kind of ties in together. Your R&D budget has gone up. You have announced that you are going to introduce a number of new products into the contractor level. And then two parts here, one, what should we expect on the R&D budget, a tick down as these products come to market, or is there a lot more going on there than maybe I realize. And secondly, just listening to the prepared comments it sounds like some of these products that you are introducing are lower price point products, a) is that a right perception, and b) do they still have the Graco margin associated with them.

Right, John as far as the development budget, I would think it would remain relatively constant perhaps pick up a bit primarily with inflation, with rate -- wage rates and so on. This year in contractor was probably our largest year ever in rollout of new equipment.

And primarily because we had the Home Depot product line involved with other refreshing of products, plus the new products that Mark talked about. Not necessarily designed for the entry-level sprayers or the entry-level contractors. There should be no margin impact on the negative side. In fact there should be a positive margin impact, and to speak of the price point, particularly if you look at Home Depot, what we're testing in there are units that are probably going to be a list price of, or a store price of about $50 more than what they are today.

What we are attempting to do is to move more features in the products that we're introducing at Home Depot. And we're also testing a brand new entry-level product, which actually will be a lower price than our DX, but it's an entry-level unit that will give you spray and roll capability.

Okay, thanks and one last question. Why was the drop in the organic lubrication sales in the quarter, what's going on there?

The -- what we had is that the fueling product systems actually were off compared to first quarter last year. That was the primary drop, the normal what we call Vehicle Services Business was basically on where it was last year. It was the fuelling products that was off somewhat, in the first quarter.

Okay, thank you very much, Dave.

Okay.

All right, thank you. Our next question comes from Mike Schneider with Robert W. Baird and Company. Please go ahead.

Good morning, guys.

Good morning, Mike.

Good morning, Mike.

Maybe we can focus on industrial for a minute. Can you give us some sense of the slow down that occurred in North America, what occurred by sub-segment, that is sealants, finishing et cetera? Can you draw any conclusions looking into the sub businesses?

Yes, at a high level Mike, what you've got is that the finishing business in industrial was weak, primarily driven by businesses like the cabinet builders, the millwork builders, so on and so forth. So that drove some of the decline. As we had said before auto was soft anyway. And then if you look at SAE, and I think probably half of our businesses in SAE is automotive, that's been weak in North America. It's been strong in -- outside of North America, but weak in North America.

And then, those businesses, which are SAE related, for instance window manufactures, the Andersens of the world, Pellerin and so on have been very slow at buying new capital equipment, as you would expect, based on what's happened with housing starts and remodels.

Okay, and would knowing that automotive doesn't seem to be going anywhere fast, certainly residential even with the low expectations is seeming to miss those expectations. What is your forecast now, or what are your expectations, I guess, for growth in the balance of the year? And by that, I mean, I'm looking at two things, one the trend line, you were up almost 30% organically in the middle of last year, and now we've gone to single-digit growth, even the negative, so the trend line isn't strong.

And then secondly, I guess, couple that with where you think distributor inventories are of this equipment to roll in to some type of, at least color on the second half of the year.

Sure, let me talk, first of all, inventory at the distributor level. I don't think there's been any significant change in that inventory level. In other words I don't think they've stockpiled inventory that would cause us any concern as the market continues to or starts to strengthen.

I think on the other side is that as you look at our business, we generally follow housing starts by six months where the homebuilders were starting to see a slowdown at the end of second quarter last year, end of third quarter we really hadn't seen that yet. And then our business, as we got into the fourth quarter and certainly in the first two months of the first quarter of this year we really started to see the impact of not only the contractor business, but those industrial businesses related to homebuilding or construction.

So, going forward, I would anticipate that we would also see a six month or so lag as before we start to see those businesses turn as the housing market comes back.

Okay, and it's your sense though that your distributors don't have excess products at this time. Because -- and I asked because we just completed a survey of $4 billion worth of U.S. distributors, and these guys are reporting sequentially more and more excess inventory such that this quarter was even an anomaly on the upside with excess inventory.

And I bring up that point because we also talked about last quarter about pricing that was going to roll through kind of in the March, April timeframe. I guess, just again some additional comments on that inventory and then how pricing flows through early in the year with that weak backdrop?

Yeah, I think that -- I honestly don't think that there is a buildup in inventory in our channel just because of our delivery requirements. I think, we are talking about being able to deliver within 24 hours. So, we don't see a lot of buildup in inventory in our distributor's locations.

Pricing, we had our normal price increase that became effective in the industrial segment in the February, March timeframe. That's flowing through as we speak, and it's about all I can tell you.

And our orders in the quarter really don't indicate that there is any kind of a buildup or buy ahead for price increases.

Buy ahead or --

Okay, all right, great. I'll get back in line. Thank you guys.

Okay, Mike.

Thank you. And our next question comes from Ned Armstrong with FBR and Company. Please go ahead.

Yes, thank you, good morning.

Good morning, Ned.

I was looking at the contractor segment and year-over-year the -- even adjusting for the product introduction and test cost, the operating income went down in pretty great proportion relative to sales with very high decremental margins. Is that indicative of the mix of the remainder business or utilization? Can you give a little bit of color there?

I'll let Jim answer that one for you, Ned, here you go.

Okay.

Ned, when we take a look at our gross margins in contractor segment, our gross margins actually increased year-over-year, quarter-to-quarter. I don't think it's a mix problem. It's really spending relative to things we talked about on product development and marketing costs.

Okay, and that's above and beyond the $1 million that you cited in the release?

Probably, in proportion to the sales decline. They did not decline as fast as the sales declined.

Right.

Okay. And then with respect to lubrication, you mentioned that the Lubriquip margins were lower than the traditional Graco margins in that product line. Is that something that's just the nature of the supply and demand in the market place, or is that something that Graco can ultimately fix by its usual cost cutting, and just operating more efficiently?

Yes, Ned, if you look at it, really it's a problem that existed with the business that we bought. We wouldn't have bought it had we not felt that we could improve the margins. I think we said that as we go through 2007 the costs associated with integrating the two factories that we're closing will have a negative impact on the profitability or have a negative impact in that we won't get the margin up to the level they -- we expect them to. But as you get in 2008, and we are running in the plant in Anoka with all of our lubrication equipment, those gross margins will come up, and I have seen nothing yet that would suggest that they're not going to be close to what the gross margins are of our existing business. And then consequently, obviously operating margin as well.

Okay, so you'll make up that gross margin differential via the cost cutting aspect or the -- and the integration aspect?

Exactly and -- yeah, there is, I mean, we're reprocessing the work. There is something that are going on that we think will have a very positive impact on our ability to improve those. I see nothing at this point that would suggest that we can't do that. In fact it's one of the reasons that we are actually accelerating the integration. We're going to be out of the operations that we bought when we bought Lubriquip a little quicker than perhaps we would have been through the normal planning process.

Okay, good, thank you.

You're welcome.

All right. Thank you. Matt Summerville of KeyBanc, please go ahead.

A couple of questions. On industrial, what -- Dave, what end markets, kind of, or applications contributed to the pickup that you saw in March? How are your fast-set foam products doing within industrial i.e. the Gusmer business? And then is that integration fully complete at this point or are there more costs that will still run through with P&L with respect to that integration?

Matt, just starting with the integration costs. Those are now complete, in fact, if you look we had a board meeting last week, and we introduced the last of the new products, and the last of the new, which doesn't -- but the last product that we actually improved based on what the Gusmer platform was. So, we now have a full Graco product line. So, the costs associated with doing that are now done. If you look at the sales in the quarter there was a little bit of a decline in the fast-set foam business. And when I say that it just wasn't growing as fast as it normally does, only because there are some association with construction, a builder, or contractor building and so on with that. But the vast the majority of the fast foams generally go into commercial buildings as compared to residential at this point. So, we still have some momentum there.

All of the other applications for the two component polyurea actually continue to grow. So, our -- what we call our AFTD business actually did grow and grow very close to what it had last year, in the quarter.

And then any other markets that contributed to the pickup and order activities on industrial in March and then does that momentum continue to the extent you have visibility into April?

Yeah, the -- if you look at our process business that we have in our industrial business, process was up as well. You know, process has been fairly predictable for us, growing at very high single digits year-over-year and we would expect that to continue. You know, the ones that cause us concern are the industrial finishing businesses and that SAE business, because, as I said earlier, half of that is related to automotive, and we're not quite sure what's going to transpire over the next few months with that.

Okay, and then just a couple of other things. In terms of the volume declines you are seeing in the professional paint channel. Has that accelerated, is it kind of leveled off, or is it gotten a little bit better as you've gone through the first four months?

It is somewhat of a loaded question, because if you had asked me that in January, I would have told you that it wasn't level as yet. But January and February are actually pretty ugly months and March was an awfully darn good month.

You know, Mark alluded to it in his comments, and that's for all of our businesses. And, as we look out, I tend to believe that perhaps there's going to some upside in the contractor business, just because, I think all of the retail outlets have driven their inventory down to lower levels than they actually need in the stores.

We have a new product that came out in February and March on the professional side. I think there will be some upside potential, but it's not going to be, as we have seen in the past, just because of the slowdown in housing starts.

Okay, and then last question. Is there any remaining or I guess, can you quantify the remaining integration expense that you will be encountering with Lubriquip?

Matt, what we expect in the second quarter would be equivalent to the first quarter, and third quarter should trail off to about 50 to 75%, and the fourth quarter will be pretty small.

Okay, great thanks a lot.

Okay.

Our next question comes from Charles Brady with BMO Capital Markets, please go ahead.

Hi thanks. Good afternoon guys.

Good morning.

Hey, can you talk about the Magnum Home Depot business. How much of the home center uptick, when you say it's up double digit, came out of new product going into those test stores.

Charlie almost none of it. It was all just volume increases in the stores. It didn't go in until very late in March, there really wasn't anything related to the new product going in.

Okay, as this continues to get rolled out and you had 1 million in the incremental cost to do this, going forward next few quarters, do we expect to see a similar cost as this product continues to get rolled out or tested?

Well, now the only thing that you wouldn't have seen is that first of all it's a 180 store test. So, we have now rolled out to almost all of those stores. The only time you would see an increase is if Home Depot decides to go with the new product offering and then we would have to roll it out to all of the stores. And really what that would be related to store reset, the [Magnum TV] we have in the stores with the redo. But you won't see 1 million this quarter, 1 million next quarter and so on, as we roll that out.

Okay, and what's being done with the -- is this going to supplant the old product or is it sort of an addition to the existing Magnum line.

Now, what it will end up doing is replacing the existing products. We put that product in the stores in 2000. So, it's been in the stores for about 7 years and what we're doing is actually bringing out an entire new line of product.

You know, the debate that we have is that it actually moves them up in price. When I say that it moves up their sale price in-store and they are really trying to test it to see if they will actually continue to sell at the same level they have.

Okay thanks. And then just one more housekeeping question. Did you break out contractor sales excluding foreign exchange impact?

Minimal, they don't really do a lot in the international markets, it's -- maybe a -- I mean, in terms of the impact it's not -- it's not that meaningful. I can give you the number. It's 1%. Did you hear that Charlie?

No, I'm sorry.

It's 1%.

1%, thanks very much guys.

Okay.

Fine, thank you, our next question comes from Ned Borland with Next Generation Equity Research, please go ahead.

My questions have been answered thank you.

All right thank you. Robert LaGaipa with CIBC World Markets, please go ahead.

Hi, good morning.

Good morning.

Just a few follow-up questions, I guess one was in regard to lubrication. I'm just trying to get a sense of what the actual number was in terms of the Lubriquip integration cost, because if I remember correctly if you look back to fourth quarter, the integration costs I thought were around $0.5 million. And they were supposed to round to about $0.5 million to $600,000 for the next three quarters.

And if I look at the margins, and I understand that the markets have weakened. The fuel for example, as you mentioned earlier. The margins have fallen from close to 22% in the fourth quarter down to the 13.5% level.

I guess my question is, what caused that significant decline outside the actual integration costs. And, if we look out over the next couple of quarters, the fact that you are closing those other -- those two facilities associated with Lubriquip. Are you actually building inventory, as you close those facilities in the interim until you have the new facility ready?

I will answer the inventory question. Yes, we are. As we make the transition, as we pull equipment out of both Cleveland and Madison, we have been building inventory ahead. And then we will ship out of inventories if we get the lines up and running here. With that I will let Jim go and answer the margin question.

Well, Bob you're right on the integration costs, what we gave you in December and what we've experienced in the first quarter are right on track. We -- as we defined that we defined that as the closing costs for closing the two factories in Cleveland and in Madison.

What we didn't include in our estimate, was our start up costs for our new factory. So, our start up costs in the quarter for the new factory were about equal to the shut down costs for the existing factories.

In addition, we found ourselves on the operating expense line having less success in getting people to move here. Though we hired a number of people, duplicating the people that were in Cleveland and those costs will disappear in the second quarter.

So, if I understand this correctly then the shut down costs were equal to the 500 to 600,000. So, the overall cost was about $1.2 million or 1 million to 1.2 million.

This is a gross profit decline.

Okay.

And then we have got a smaller number but still substantial in operating expense, 4 to 500 as we duplicated our order entry people, to be able to handle customer orders in Minneapolis versus Cleveland, as we duplicated marketing positions, and as we duplicated some of the product engineering people.

Okay and I guess, just as to follow up I guess there is another -- one more clarification there. The fact that you are building inventory of these lower margin products. At least for the time being they are lower margin. I understand that moving forward you are planning on raising the margin especially in '08.

How much of that -- how much of that increase in inventory has been completed, or should we expect additional inventory building into the second and third quarters or is most of that actually completed here in the first quarter?

If you're talking total inventory no, if you are talking Lubriquip yes. You will see additional Lubriquip inventory build. If you looked at the -- I think it was $10 million that our inventory increased in the quarter, basically what that was, was related to the introduction of the new product in CED. There was a supply chain that we were filling for Europe, because of increased sales there along with Asia, we've got a little more inventory in our warehouses in Asia, and then the remainder was with the integration of Lubriquip. But yes, Lubriquip will go up also in the second quarter that being inventory going up.

Okay and then, one more question if I could. Just, if we tie that altogether into SG&A expenses, SG&A expenses were as a percent of sales roughly 140 basis points higher year-over-year. Are you expecting them to be up a similar amount year-over-year in the second quarter or should we expect that to actually trail off, because I understand you have the new product development costs in contractor or some other items here, some of this other stuff is being front loaded. What is your expectation there going forward?

Bob, the main reason our G&A costs were up, as Mark mentioned earlier, were our amortization costs related in -- for most part to the Lubriquip acquisition. D&A expenses were -- have been fairly flat for about three quarters at the $15 million range. So, we would expect to be at that level or slightly less.

Okay. Thanks very much.

Okay.

All right. Thank you. Next, we have a follow-up from John Franzreb. Please go ahead.

With the Gusmer acquisition complete can you talk a little bit about the margins in that business, are they now comparable to historical Graco margins?

John, yes. It's a simple answer that they are certainly running at what our margin levels were before we bought Gusmer as of now.

Okay, great. And can you talk a little bit about replacement parts, and how they figure into the sales mix today, say versus six months ago? Are they ticking up? Can you just talk a little but about that and what's happening there?

Now, it's a phenomenon that frankly I don't completely understand. The parts and accessories business remains at the same levels it does regardless of how much equipment we're selling, which -- now you would think in a downturn that you probably you are not selling more parts because people wouldn't keep the equipment repaired. That's generally not the case, but they are about the same level they have been.

And what were they in the quarter about Dave?

40%.

40%, okay. And one last question. What is the CapEx budget going to look like this year?

About $50 million for the full year.

$50 million?

Yes.

Thank you very much, Mark.

Yes.

All right. Thank you. And a follow-up from Mike Schneider with Robert W. Baird. Please go ahead.

All right, guys. Maybe at first we can address -- did I hear you right, Jim, that gross margins in contractor were actually up this quarter?

That's correct.

Obvious question. But how in the world can that be given the decline in volumes overall, especially in North America, which is presumably your higher margin market?

Well, I think your presumption is probably not correct. Margins in Europe --

Were actually better.

-- and Asia are actually better than they are in the U.S.

Is it the case though where you didn't trim production yet during Q1, so absorption was still good and now Q2 is where you really suffer the lower absorption rates as you trim production and try and trim inventory to adjust to the market demand?

No, we don't think so. We think that, again, our second quarter is generally our highest volume in the contractor business. So, we expect roughly the same level of production in the second quarter as the first quarter. So, absorption will be about the same. We do have a number of process improvements that we put in place in that factory as well that were implemented in the fourth quarter of last year and the first quarter of this year. So --

So, you don't view --

We are not projecting any cost pressures.

Okay. So, you don't view your contractor inventory specifically as too high vis-a-vis what's going on during the quarter with end-market demand?

Not -- again, part of the issue, of course, is the fact that we are delivering so much more volume of U.S. made product to Europe. So, our supply chain extends by the time it takes for the product to get across the water. We believe that will continue. We do see the new product introductions, that we referred to earlier, happening mostly in April and May this year versus earlier in the year last year. So, we'll see some small decline in inventories in the contractor business.

Okay. And so, with those production plans in place are you producing at a rate where you actually expect contractor to be up for the year still, or have you trimmed your expectations?

Well, I think we expect the European and Asian business to be up for the year. We expect the North American business to recover slightly. On the second quarter, hopefully, the last half of the year will be more positive comparison to 2006.

Okay. And then, specifically, on the parts sales, Dave, you mentioned still steady at 40%. Are you seeing a -- any entree of some of the parts replicators, I know you and I have talked about this in the past, but could that explain where the excess -- what we might expect as excess sales going?

No, not at all. I mean there are the, what we call the [well fitter] there is really one out there that is very strong. But he has -- as far as we know, and as far as we measure, and measure very closely, we don't see any additional parts business going to anyone else other than us.

Okay. And then taking a step back now, with the revenue progression during the first quarter. Have you reevaluated what you believe your actual construction exposure is? Obviously, contractor is there, but it appears as though there is more construction exposure in the industrial segment than maybe we appreciated? Have you done some fresh analysis as to where this product is all going, or what the true construction exposure is?

No, we have not done that. I think we always knew internally that there was some industrial business at risk based on what was going to happen with new housing construction. But, no, we have not gone through an analysis to try to determine what the exposure is.

What percentage do you put as tied to housing or just construction generally across the enterprise?

Mike, I couldn't sit here and tell you that. I have to go back and look at the numbers. I can't give you that number.

Okay. And I believe that's it. Thanks again, guys.

Okay.

All right, thank you. Our next question comes from Steve McNeil with Jennison Associates, please go ahead.

Good morning. Can you give us the specific numbers on the home center growth and the professional paint store channel decline?

The specific numbers meaning the --

The percentages, yes.

Yes.

We generally don't disclose those. We'll say that the paint store channel, the professional paint store channel was down double digits and home center was up double digits.

Now, can you give us the proportion of the mix there pro versus home?

The best way to look at that is that Depot is about a $60 million customer. Our contractor business last year was $350 million or so. So, the home center business would be $60 million of that 350.

And the remainder being professional paint.

Right, yes. And then some of that's international too, right.

Yes.

That remainder.

Okay. Now, I'm just struggling with the contractor margin [delta], we had -- the discussion with Mike that indeed the international business has a higher margin than the domestic business. Can you just give us a bridge then on the 390 basis point delta? The easy one to get to is the 140 basis point of spending that you've called out related to the new Magnum sprayer line, so what's the other 250 basis points there?

I think it's volume related. It's the fact that our costs did not decline. Our selling and product development costs did not decline at the same rate the sales declined. So, if you look at our base product development to a smaller sales base, our percentage of sales went up. Our base selling cost as a percentage of sales went up. Really volume related on the top line and the leverage we get from more volume through our channel.

Just within North America, though.

That's correct.

All right. So, how much did the growth in international help it then? Because that 250 is presumably a net number right?

We're looking --

I'm not sure I follow your question, the 250.

Well, the 250 -- so the margins in the segment declined 390 basis points.

Right. It's --

140, that was from the spending, and the 250 of that was volume related, which is a net number of the North American decline and the international growth.

Correct.

So, I mean, what's -- I guess the flow through on the international growth would be kind of, like what's the right number there?

Are you asking whether the international growth delivered a greater percentage of sales?

No, I'm just trying to get a sense for how much the flow through on growth would have been as it relates to the international within that segment.

Well, so if I take a look at Europe our percentage --

Is it like a 30%, 25% flow through kind of number?

Our percentage increased by a couple of hundred basis points. Our Asian business declined as we have invested more in our selling and expect greater revenues in the last three quarters of this year. So, that declined few hundred basis points. But again you're not talking very significant dollars --

Right, they're very small.

Okay.

Our expenses are predominantly in North America.

I understand. Okay. Thank you.

Okay.

(OPERATOR INSTRUCTIONS). And seems that there are no further questions. I'll turn the conference back to Dave Roberts.

We'd like to thank everybody for attending the conference call. Obviously, we were disappointed in the results in the first quarter. But we think that the investments that we made certainly are investments that will payoff going forward in the business. So with that, again, thank you for calling and we'll talk to you next quarter.

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