Graco Inc (GGG) 2007 Q2 法說會逐字稿

Good morning, and welcome to the second quarter 2007 conference call for Graco, Inc. If you wish to access the replay for this call you may do so by dialing 1800-405-2236 within the United States or Canada. The dial-in number for international callers is 303-590-3000. The conference ID number is 11093038. The replay will be available through July 29, 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 99-2, the Company's 2006 annual report on Form 10-K. This report is available on the Company's Website, at www.Graco.com, and the SEC's Website, at www.SEC.gov. Forward-looking statements reflect management's current views and speak only as of the time they are made. The Company undertakes no obligation to update these statements in light of new information or future events.

During today's presentation, all parties will be in a listen-only mode. Following the presentation the conference will be opened for questions. (OPERATOR INSTRUCTIONS) Now, at this time I will turn the conference over to Mr. Mark Sheahan, Chief Administration Officer. Please go ahead.

Okay. Thanks, Michael. Good morning. I'm here today with Pat McHale and Jim Graner. We will review our second quarter results, and I will start out by making some overall comments. The quarter was a good quarter for Graco, our sales were $231 million that was 6% ahead of last year. We had favorable impact from the Lubriquip acquisition and foreign currency translations, which added about 4 percentage points of the growth in the quarter. On a geographic basis, our sales in Europe and Asia were up 29% and 8%, respectively. And that more than offset the 2% decline in sales that we had in the Americas. If you look at the Americas our sales were lower, really due to the contractor business that business was down 10%. As noted in the release, our industrial sales in the Americas were up 1 percentage point and lubrication sales were up 28% for the quarter. Our gross profit margin was 52.8% for the quarter compared to 53.5% last year. We had favorable impacts from foreign currency exchange and pricing but they weren't enough to offset the lower margins that we had on or Lubriquip business as well as some of the consolidation costs and higher material costs that we were experiencing in manufacturing.

Our operating profit margin was a record this quarter at 29.3%. And our total operating expenses were up slightly at $54.5 million this quarter versus $53.1 million last year. On a net basis, our net profit margin was again a record at 19.1% in the second quarter. And then we also, in the quarter, noted in the release that we repurchased approximately 1.4 million shares for $57 million. Year-to-date our share repurchases were 2 million shares for approximately $81 million.

Next I'll talk briefly about each of the operating segments. First of all, in industrial, our second quarter sales were $114.3 million that was up 9%. On a constant currency basis our sales were up 7. In the Americas, as I noted before, the sales were up 1% so most of the growth came from Europe and Asia, where sales were up 28% and 5%, respectively. Our second quarter operating margins in industrial was 34.6%, which was compared to 31.1% last year. And that really was reflecting the higher impact of the higher sales that we had and some of the improvements that we were realizing with respect to the acquired businesses in that segment i.e., the Gusmer in particular.

Sales in the Americas were a bit disappointing for us in industrial in the second quarter, although they were better than what we experienced in our first quarter results. Obviously, the international side of the business remains strong and I'm sure everybody knows the comparisons there will become more difficult in the second half of the year. As we noted in the release we remain cautious in our outlook for the second half of 2007 in the industrial segment.

With respect to the contractor business, when compared to last year, our worldwide sales were $94.2 million, which was a 2% decline. That was really the result of the Americans, which were down 10% -- they were down 10% versus last year. And most of that decline came in the home center channel. Housing conditions remain weak in the US and we expect that that will continue for at least the rest of the year. In Europe, the sales continue to be very strong. Our sales were up 29% this quarter. And growth occurred throughout the region in Europe.

In the Asia-Pacific region our sales were up 16% in the quarter. But again, that is of a pretty small base. I mean we had more or less growth throughout the region there as well. Our operating profit margin in the second quarter for contractor was 30.4% versus 30.6% last year. So, pretty good performance on the operating margin side of that business.

Next, looking at the lubrication segment. The second quarter sales for lube were $22.9 million. That was up 30% from last year. That was really driven by the Lubriquip acquisition, which contributed 29 percentage points to that growth or about $5 million. The operating profit margin for the quarter was 9.6% compared to 25.4% last year. And that decline was mainly due to the lower margins on Lubriquip products and consolidation and integration of the lubrication operations that we had planned and discussed. Our operating profit margin was about equal to last year without the impact of the inefficiencies and the expenses that occurring as a result of the consolidation of the Lubriquip business. Again all those activities were planned.

Tax rate for the quarter was 34%. That was a percentage point lower than last year's rate for the second quarter. And that was really the result of recognizing some benefits from our foreign entities. Some other items in the release that are worth noting. Year-to-date our share repurchases again were approximately 2 million for $81 million. And we have about 3 million shares remaining under our current authorization, which expires in February 29, of 2008. Our unallocated corporate expenses in the quarter were $2.6 million, which was consistent with last year. The currency impact in the quarter, currency added about $3.5 million to our revenue and about $1.5 million to our net earnings. And on a year-to-date basis currencies added about $7 million to revenue and about $3 million in net earnings.

Our backlog at the end of the quarter was $40 million that is up $5 million from 2006 year end and it is consistent with where we were a year ago. Our inventories were up $5.5 million at the end of -- from the end of 2006 but down $5.5 million from the end of the first quarter. Accounts receivables were up $26 million from the beginning of the year. DSOs are at the same level as they were at the end of 2006. Our amortization expense was 2.1 million in the quarter and depreciation expense was $4.8 million in the quarter.

To summarize we continue to experience lower than expected sales in the Americas but our international businesses is strong as expected our professional contractor business remains soft in the Americas but again it is very healthy in Europe and Asia. We continue to make good progress with our acquisitions and the integration activities. We are on track with our scheduled completion date and the spending there is more or less on plan with what we had expected. At this point that concludes the opening remarks. I'd ask Michael to open up the call for your questions.

Right, thank you. And the question-and-answer session will begin at this time. (OPERATOR INSTRUCTIONS) Please stand by your -- for our first question. And that is coming from Mike Schneider. Please state your company name followed by your question.

Hi, Robert W. Baird & Co. Good morning, guys.

Good morning, Mike.

Maybe, first we can just drill down in industrial for a minute. Mark, you made the comment that performance and industrial in the Americas was disappointing. Can you give us some update on -- as you've had time now since the first quarter to dig into the weakness, what are the weaker segments within industrial? And maybe, you can also give us some color just by sub unit that is the four units, adhesives etc.

Hi Mike, this is Pat McHale. How are you?

Great, thank you.

I will give you a little bit of color on the industrial business. North America, the industrial business, the headwind that we are facing there is the segments of our industrial business that are housing related. Now, we've got window and door business, we've got some finishing business in terms of cabinetry and furniture and some of the fine finish business. And then of course the automotive headwind that we face impacted our sealant business and our RIM business. We have segments in industrial, of course, North America there a very strong aerospace, oil and gas, chemical, some of the sanitary businesses. So it is a kind of a mixed bag in industrial in the current situation.

Okay, and for example on some of the higher growth markets could you give us some examples of the fast set foam etc. What is growing within the Americas still and actually keeping that growth rate actually from going more negative?

Well, the fast set foam business, Mike, has been pretty good for us, really, across the board both in the Americas and in the international markets. I should say that the growth overall for that business is in line with what we expected on a worldwide basis. The international markets are actually a little bit stronger than the Americas. But again, in an aggregate basis we are pretty comfortable and pleased with what that piece of the business is doing for us.

Okay, and industrial generally, in the Americas we talked last quarter that January, February was extremely weak that March had bounced back. Can you walk us through what the trend was during the second quarter?

Yes, I think it was we didn't really see that impact in the second quarter. I would basically characterize the bookings as pretty consistent throughout the quarter in all three of the months. But we did see growth as was noted and obviously in the first quarter of this year we had a pretty substantial decline there.

Okay, and next question and I will get back in line. Just operating margins within contractor. How does one add several hundred basis points to operating margin, while organic growth was actually minus 2%. Just any color on just how much is coming out of Gusmer etc? I'm sorry not Gusmer but the other acquisition.

Mike, it's Jim Graner, one of the things we mentioned is our strong business in the rest of the world, outside of North America. As we have talked before that has slightly better gross margins, better operating margins also shift in mix from the home center to paint channel in North America also does the same. And then also we had some start-up expenses, if you remember right in the first quarter with respect to the new products that's being introduced into the home center channel.

Okay, thank you again.

Thanks, Mike.

All right, thank you Robert Lagaipa, please state your question -- respond with your company followed by your question.

CIBC World Markets. Good morning.

Good morning.

I guess a couple of questions. I guess, one, I wanted to get additional color on the accounts receivable growth, this quarter and last. I mean, if I look historically, these last two quarters accounts receivable growth has exceeded sales growth by -- over 700 basis points in the first quarter and the second quarter here over 950 basis points. I'd have to go back all the way to first quarter of '02 to find a variance that large. Can you maybe just speak to that and give some additional color?

Sure, Bob. When you look at that internally by the region and when you measure it by the actual date that the sales are coming in you will find that fairly consistent with the end of the year. It is a little bit higher than the same quarter last year and really the driver there is the mix of export and international business were the terms are longer than they are in North America really do it as a selling cycle with our distributors out -- so there are really no issues there with past due to receivables. It is just the mix, Europe versus US. And then also there is the currency impact increasing those as well.

So we should expect this variance to continue, especially as international is very strong?

Yes, I would say that we are at the level where we expected to be again this days of sales are fairly -- are flat by region. So sales growth from this point forward of course would add to receivables but if the mix stays here or if the mix shifts more to the international business versus Americas it will grow.

Okay. And second question is related to share repurchases. You obviously, have 3 million left on the program. What I also noted is from a total debt to capital perspective you have moved this to levels north of 16% and we haven't seen those levels in good six years or more. I guess my question is, it seems like you are levering up a little bit, is it related to share repurchases or should we expect the share repurchases to jump up from here on out? Is there a plan in progress to increase the authorization or renew the authorization at a higher level? Can you maybe just talk about that as well?

Sure, as you know, at the end of June we had 3 million shares left on our open authorization. We have the credit facility in place for us to be able to execute that. And as you have seen in the second quarter we are buyers at the current prices. So we do feel that is a good buy for us and we feel that is a prudent use of leverage to do that.

So do you think this 1.4 million that we saw in the second quarter that accelerates and this 3 million is completed before the end of the year?

Depends on the share price and what other opportunities the Company has.

Of course, and the last question if I could -- just need the costs. Obviously, you did a phenomenal job in terms of the expense control here in the quarter, and I guess my question is what were the costs associated -- just remind us what the costs were for the home center promo in the first quarter versus the costs associated with the plant consolidations? What they were here in the second quarter, and what you are expecting moving forward for the rest of this year, as you complete the program?

Yes, in the first quarter we have $1.5 million split between product development and marketing expenditures for setting that new product into the home center channels. In the two quarters, first and second quarter the costs of integration are about exactly the same for the Lubriquip and the consolidation of our lube factory in one location in our new plant in Anoka. We will see that trail off a little in the third quarter and a little more in the fourth quarter, but our main impact on that will be in 2008.

And where there any -- it would been $1.5 million for product development and marketing. I think last quarter you mentioned some of that might leak here into the second quarter. Was there any leakage a few hundred thousand or did it pretty much complete itself?

It was in that neighborhood, a couple of hundred thousand or less for less than --.

Okay, terrific. Thanks very much.

Right, thank you. John Franzreb, please state your company name followed by your question.

Sidoti and Company. I was wondering about that cautionary statement you threw out there on the industrial side of the business. I guess some of those end markers where you kind of pointed out they have already pretty much pulled back on a lot of the spending. Which markets do you think might pull back even further so that it gives you that cautious outlook for the second half?

This is Pat, John. We have -- we sell through distribution and our products go into a lot of end markets. And certainly, you see the same numbers that we see on the housing and the automotive production markets and that really gives a rise to our caution. However, we do have a lot of business segments in North America that are strong right now. So we got kind of a mixed bag and what we are trying not to do is read too much into a one quarter sales number in terms of projecting the end of the year based upon some of the uncertainties we see out there in the economy.

Okay second question is I can't remember the last time you really kind of pointed out raw material costs as being an impact on the margin. Could you just talk us through what is going on in the raw material costs and why it is becoming such an issue?

Well, I would classify it not as much as an in issue in the mixed bag of things we see our margins flat to last year without the impact of the factory moves and Lubriquip integration. But we are experiencing about 1 percentage point margin loss to material costs. But again we've got some pricing that's gone on and those things really are offsetting each other on the gross margin line.

Okay, and you mentioned the Lubriquip can you kind of update us on what the next moves you plan on making, and what the time frame is for getting that business up to a Graco-type margin?

Sure, the Lubriquip business from a physical relocation standpoint we will finish that up in the third quarter here we are very close to having that complete. We still have to move the lubrication business that we have at our Minneapolis factory up to integrated with the -- lubricated with the Lubriquip businesses in our Anoka facility. So that is really why the project will tail through the end of the year. Our focus going into 2008 and then we will have the physical move costs behind us we should have the inefficiencies associated with all the new people and the training that we are going through right now behind us. And going forward into 2008 our manufacturing people will begin to reprocess that work, take out costs, improve our fixtures and tooling, and we will be driving that business towards Graco levels. That will be a process that will go on through 2008, 2009 much like you saw with Gusmer I think you will see an ongoing improvement in the gross margins of that business going forward. Again, beginning in 2008.

Okay, great. And one last question. The home center channel, can you just kind of comment on inventory levels or perceive the inventory levels relative to where we are this time of the year, and maybe some kind of color with your -- now your customers saying -- regarding the second half of the year buying patterns?

Sure, on the inventory side Home Depot went into the end of last year with a very low level of inventory on the shelf and we did see some restocking activity in the first quarter that looked good to us. But with the current housing conditions and of course, I think, Home Depot's challenges are well-publicized. We did see them pull back in the second quarter and we believe their inventory levels now are pretty consistent with where there were right about the beginning of the year they had a little buildup in the first quarter and they have taken that back here in the second quarter. So our in-the-door sales to Home Depot are pretty much in line with their out-the-door sales on a year-to-date basis although we had a negative impact on the second quarter.

Great. Thanks very much part.

I give you Charles Brady, please state your company name followed by your question.

Thanks. BMO Capital Markets. I mean, on the lubrication segment just (inaudible) the integration costs for Lubriquip it looks as though the margins were still down. Is there anything else within Lubriquip that was maybe weaker than you would have expected going into the quarter?

Nothing that we -- nothing weaker than we expected Charlie, but what we are experiencing is with all the moving and all the inefficiencies and the factory, those costs are running through the cost of goods sold line. We've got multiple Graco people multiple Lubriquip people involved with those facility moves and that is just creating some inefficiencies. But again it was all planned and kind of what we expected.

Okay, and then on the new Magnum line you were test marketing at Home Depot. What is the status of that right now?

The current status of that test is we are still in the same number of stores we were in and the test is still progressing. We should have maybe another look at some feedback on that in the September timeframe. But we don't really have a lot of information to share at this point.

Can you quantify the decline in Depot and the lesser decline in paint channel?

I can tell you that in the second quarter our Depot business was down double digits. Our paint channel was not down that far on average but it varies between major customer segments.

Okay, and one final question. Just as we look at the back half of the year on the tax rate any substantial changes you would envision or still around 34% is a reasonable assumption?

Under the new rules the tax rate quarter-to-quarter will be more volatile than it was in the past because we have to wait for a discreet events to happen or take place before we can recognize the benefits. And we look forward -- and you would want to measure quarter-to-quarter I would say 34% plus or minus 1 percentage point would be the normal range that you would see us in but there will be some volatility. Going forward, I would say you can use 34% on the long-term kind of rate look.

Thanks.

Right, thank you. Ned Borland, please state your company name followed by your question.

Hi, Next Generation Equity Research. Just sort of comment on Europe industrial growth. Pretty impressive there. Is this more a commentary on the economic conditions improving over there or is it more about your expansion in the distribution?

I think that the growth that we saw in Europe is made up of a variety of things. We launched some new products in Europe. We've added salespeople and distribution coverage and into new areas. The economy over there is pretty strong; 28% growth rate in Europe is not something that you'd probably want to model as a sustainable growth rate there. But we think we've got a good aggressive program over in Europe to continue to grow that business through our core strategies of distribution, expansion and new product development.

Okay, and maybe I missed it but did you guys give out an organic growth rate for lube, earlier?

Our base LED business excluding Lubriquip was up about 3.5% in the second quarter.

Okay, great. That's all I had. Thanks.

Thank you. Matt Summerville. Please state your company name followed by your question.

Good morning, KeyBanc. A couple of questions. Just on the industrial business, with the nice jump up we have seen in margins now to the mid-30s kind of range. I guess, how should we view the sustainability of that going forward. I mean is the margin bar in this business been reset again?

Well, again, part of the driver there, Matt, is the improvements that we are getting from the acquisition. And I think that those are real dollars and real improvements. And I guess, our expectations would be that we are going to continue to be able to realize nice profitability from those as we move forward. We are probably not fully done there yet. The Graco motto is always to not necessarily rest on your laurels and try to improve. So we never really set margin target expectations for our company but our expectation will be that we aren't going to necessarily go backward there.

What kind of growth rates are you seeing in your fast set foam business right now?

Double-digit, mid-teens type of growth rates on a world-wide basis.

And how big is that business I guess for you guys now, like $75 - $80 million worldwide?

For competitive reasons we've made a decision really not to disclose that.

Okay. You mentioned, I think, Mark, in your prepared remarks for us to keep in mind the comparisons you face in industrial and some of the other outside North America geographies in the back half of the year. Can you give us a little more detail? I know we can go back and look. But how challenging are your comparisons in the three regions, I guess, moving into the back half?

Let me get the numbers here.

And then maybe while you're looking that up, Jim, can you give us a forecast for CapEx and D&A for the full year '07?

Sure, our current outlook for capital expenditure is $45 million at the same level we disclosed in our 10-K. We might spend a couple of million less than that but that would be a good point to reference our -- D&A should be in the $26-$27 million category. And $19 to $20 million of that is depreciation and the rest is amortization of intangibles.

Okay, great. Thanks.

In the fourth quarter last year -- in the third quarter last year, Matt, the industrial segment was up 15%.

Yes.

And the Americas it was up 19 and then in the fourth quarter of last year the industrial segment was up 14% and the Americas were up 9.

Okay, great. Thanks a lot.

Yes.

Right, thank you. Mike Schneider, please go ahead with your follow-up question.

Mark, maybe you can give us some sense on lube what expenses will be rolling through Q3 and Q4 related to the final facility move and then the Anoka I'm sorry the Minneapolis move into Anoka?

Well, I think what Jim said is probably accurate. We expect that, if you look at the expense we broke out in the first two quarters I think was 600,000 each quarter. We would expect that there will be similar expenses in the third quarter but maybe a little bit less. And then in the fourth quarter that is going to taper down pretty significantly. But when it comes to some of the inefficiencies in the manufacturing and the moving and all that stuff we are going to really be experiencing that throughout the rest of the year.

Great. Okay, so you would expect margins not to return really to their historic 20% plus level until what, mid '08 or something?

Probably, a good guess.

Okay, and then just industrial, you called out here now the Americas were up [19 and 9] in the second half of last year in industrial. How should we frame that because industrial did accelerate sequentially it was up 3% worldwide, that is in Q1, 7%. This quarter is -- is it just the foreign operation that are accelerating and starting to overwhelm the Americas' weakness or did the Americas actually get better in your opinion, any color on that because it is difficult now to model industrial with the tougher comparisons coming ahead but yet with seemingly better business worldwide for industrial.

Yes, it's tough for us too that is why we made the comment. But basically, what it boils down to is we had a quarter here where we had 1% growth in the Americas. And yes it is better than what we had in the first quarter down double digits in the Americas. And we're just not in a position to be able to give you any more clarity. We have a short backlog business, we have two or three weeks of sales in our backlog so we really don't have a lot of visibility there. I think the comments Pat made are accurate. It's a mixed bag. We've got some markets that are good. We've got others that aren't. And we're going to push the Company for growth but right now it's a mixed bag.

But the-- in Q1 versus Q2 on some of these residential related markets automotive, windows, furniture etc., do you sense that in hindsight there was an inventory liquidation going on at your distributors that maybe reversed itself in Q2 so we're going to settle in to the middle or did conditions actually bottom?

I will just give you this, for the most part especially on the industrials side don't carry a lot of inventory. We ship pretty quick here in North America pretty much everything that comes in will ship out the same day or within a few days. And we sell such a broad product offering that it doesn't make sense for our industrial distributors to do a lot of inventory stocking. So I don't think that in industrial North America that changes in inventory are really going to be a significant factor in what our sales are going to be.

Okay. And that just Pat, just from a more top-level perspective. Now, as CEO you've witnessed George Aristides come through and Dave Roberts come through and the track record [obviously] of the last decade and longer has been spectacular and you have been part of it. At the controls today though, I guess, give us your vision for the business. And not to sound tripe but what you would expect your legacy to be whether its acquisition, international, margins any insight as to what might change or at least shift direction under your leadership?

Sure, I have seen a lot of change in leadership in Graco during my 18 years here. It has been interesting. I hope I have learned the best from all of them and I can combine those skills in to creating a legacy of my own. I think it is a little early after just this many weeks to be even thinking about a legacy. But I can tell you about my management philosophy my agenda is as I see it now. Certainly, I think if a company doesn't have good strategies no matter how well you execute you're not going to be successful. And I do believe that the strategies that Graco has in place today are sound. So I don't think you should expect to see a significant strategic shift in direction of the Company with me at the helm. I've got a lot of passion for new products process I think that does a lot for us. In addition, it is just the financial results that makes life difficult for our competitors. I am going to continue to be a big supporter of that. International expansion is very important for us. We will be doing that aggressively. We are learning about acquisitions, we have done more over the last few years with the Dave being here. I think that they can be a nice component of our growth. I don't think you are going to see a big shift in the size or the impact they have on our total growth. But we are learning and I think that we can do better. In terms of my management philosophy is really we've got a strong management team here, we've got talented employees. I expect every employee to contribute to annual improvement and Mark talked a little bit about it. But I'm an operational excellence guy, a continuous improvement guy. I believe that we've got to have good metrics for every employee. I believe in individual accountability backed based decision making and that is the path that we are on and the things that I intend to push.

Thank you.

Right, thank you. John Franzreb, please go ahead with your follow-up question.

Yes, I was just wondering if you guys could break down the contractor segment of revenue by geography and maybe actually the same in the industrial.

Yes for the quarter, John, the contractor's sales in the Americas were $67.2 million. In Europe, there were 20.3 and in Asia there were 6.6.

Industrial.

I'm sorry what other ones did you ask?

Industrial.

Industrial, Americas, 54.7; Europe, 36.8, and Asia, 22.8.

Thank you, Mark.

Yes.

(OPERATOR INSTRUCTIONS) And there are no further questions I will now send the conference over to Pat McHale.

Sure. First of all I would like to thank you all for your time this morning, and of course, for your interest in Graco. Hope the message that you got is that although you face some significant headwind in North America especially related to the housing market that we do have a good geographical and market diversity across the Company and that provides us opportunities to grow our sales and earnings. And we're going to continue to work hard to do that. I would like to thank our employees and our distributor partners for their efforts during the quarter. A special recognition to the teams in Europe and the teams in Asia who have had especially outstanding results during the quarter. I look forward to traveling in the coming weeks and months and meeting with analysts and investors. I would also like to extend an invitation to any of you to come to Minneapolis for discussions and see our operations. If you're interested please contact mark and he will coordinate the schedules. Thanks again and that concludes our call.

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