Graco Inc (GGG) 2011 Q1 法說會逐字稿

Good morning and welcome to the first quarter 2011 conference call for Graco Inc. (Operators Instruction). Graco has additional information available in a power point slide presentation which is available as a part of the webcast play back. At the request of the Company we will open the conference up for questions and answers after the opening remarks from the management. During this call various remarks may be made by Management about the expectations, plans, and prospects for the future.

These remarks constitute forward-looking statements for the purposes of the Safe Harbor provision of the Private Securities Litigation Reform Act actual result may differ materially from those indicate as a result of vary risk factors including those identified in item 1-A of and Exhibit 99 to the Company's 2010 annual report on Form 10-K and in item 1-A of the Company's quarterly report on Form 10-Q for the quarter ended April 1, 2011. These reports are 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 that they are made. The Company undertakes no obligation to update these statements in the light of the new information or future events. I would now turn the call over to Caroline Chambers Vice President and Controller.

Good morning everyone. I am here this morning with Pat McHale and Jim Graner. I will provide some comments on the financial highlights of our first quarter and Pat will follow with some additional comments. Slides are available to accompany our call and can be accessed on our website. The slides include information about our consolidated financial results in each of the segments.

After opening comments we will open up the call for your questions. The sales momentum from 2010 continued into the first quarter of 2011. Net sales were $218 million for the quarter, up 32% as compared to the prior year with double-digit growth in all segments and regions. Currency translation did not have a significant impact on the quarter.

Overall, volume increases drove improvements in gross margin rate and improved leverage on expenses. Operating earnings for the quarter as a percentage of sales were 26%. Up from 20% a year ago. Net earnings totaled $37 million or $0.61 per diluted share.

Gross profit margin in the quarter as a percentage of sales was 57% compared to 54% in the first quarter last year. Higher production volumes fully absorbed fixed manufacturing costs the in first quarter of 2011 improving gross profit margins by two percentage points as compared to the first quarter of the prior year. Material costs in the first quarter were slightly unfavorable as compared to the first quarter of the prior year offset by selling price increases.

Material cost pressures are expected to continue throughout the year. Operating expenses increased by $11 million or 19% compared to the first quarter last year. This increase includes an additional $8 million in selling and marketing. Product introductions primarily in the contractor segment accounted for approximately $3 million of the higher marketing costs.

The stronger business levels in Q1 this year drove higher levels of incentive accruals as compared to Q1 last year. [Focused] headcount additions in sales and marketing also contributed to the higher expense level. The effective tax rate for the quarter was 34% compared to 34.5% for the first quarter last year.

The rate this year included the benefit of the federal R&D tax credit which had not yet been extended in the first quarter of the last year. First quarter cash flow from operations was $14 million as compared to $16 million last year. Our working capital requirements increased in line with our increasing volumes.

Increases in accounts receivable were $29 million with days of sales outstanding remaining consistent with prior periods. Inventories increased by $11 million as our factories improved service levels on key products and International distribution inventories increased. Other primary uses of cash in the quarter included capital expenditures of $4 million in dividends and $13 million.

The first $150 million of the long-term debt that was previously announced was drawn down in March and the proceeds were used to repay the revolving line of credit borrowing and remainder invested in cash equivalent. Our backlog continues to be strong increasing $6 million from year end. Going forward we anticipate continued material cost pressures. Strong factory volumes and efficiencies should help offset higher material costs.

Our rate of incentive accruals was lower in Q1 as compared to Q4 of last year. But the strong growth in the later quarters of 2010 our comparable growth rates will become tougher and our ongoing incentive accrual rates will reflect the Q1 growth rate only if we see that coming through in the actual growth rate. We are expecting to return to the normal seasonal pattern of our business particularly in the contractor segment.

We expect Q2 interest to be approximately $2 million and expect to draw down the additional $150 million of the previously announced long-term debt in July. We are beginning the regulatory approval process related to the acquisition of the finishing group of businesses from ITW and currently anticipate the transaction to close in the third quarter of 2011. Transaction costs in Q1 were minimal but anticipate costs of approximately $5 million in Q2. Total transaction costs are expected to be in the $15 million range. With that I'll turn it over to Pat for additional comments.

Good morning. I'll begin with Europe where revenue increased 27% versus Q1 of last year. Our sales increased at solid double-digit rates in Western Europe, Eastern Europe, the Middle East an Africa and were strong across all product categories.

While overall European Q1 sales are still slightly below our pre-recession peak, sales in developing countries are now back above peak. We believe this performance reflects both the economic potential of the developing markets and our significant investment in people and channel. Our Industrial business in Europe performed well growing 24% versus last year, Contractor equipment sales in Europe increased 33% compared to Q1 of last year and surpassed our 2008 peak Q1 at constant exchange rates.

New products contributed about half of the increase. Through the balance of the year we expect residential construction in the region to improve modestly and commercial construction to be flat to declining. Lubrication equipment continues to grow nicely in Europe off a small base and also exceeded our pre-recession Q1 peak at constant rates. We continue to be positive regarding our growth prospects for Europe in 2011.

Switching to Asia-Pacific. Asia-Pacific is off to a good start with 35% growth over Q1 of last year and we had double-digit increases in both developed and developing countries and across most product categories.

Business in Japan was also up double digits although we do expect some short-term negative impact from the earthquake this year and a likely positive impact in 2012. Note that Japan accounts for less than 3% of total Graco revenue. 2010 Asia-Pacific significantly exceeded our pre-recession peak.

We have invested heavily in people and channel during the past two years and our 2011 plans reflect significant additional incremental investment for commercial people, customer support, and training. We continue to be positive about our growth prospects in Asia-Pacific for 2011.

Now on to the Americas. In North America all segments were up double-digit compared to last year. Our Industrial segment continued to perform extremely well with double-digit growth in all major product categories. Strong markets include automotive, ag, small aerospace, energy infrastructure and general Industrial.

Our residential insulating foam business also continues to grow well despite low levels of new home construction as the market continues to adopt this technology. The Lubrication segment is off to a good start. We had double-digit growth in both our vehicle service channel and our Industrial Lubrication channel. With Industrial lube growing faster.

Operating margins for the Lubrication segment continue to improve. However, the operating margin of 21% achieved in the global lube business in Q1 is expected to moderate into the high teens for the balance of the year as we continue to invest for growth.

In Contractor North America revenue grew strong double digits in both propane and home center. The home center growth was primarily driven by the product load associated with the expansion of outlets. This increase in channel presence should help home center volume all year.

Growth in the paint channel is driven by the continuing success of new products. However, we are also seeing early signs of improvement in base business. Although end market conditions in the US remain very depressed, our field personnel believe that the glut of painting equipment in the market when housing crashed in 2007 may be reaching depletion.

There's no way for us to accurately measure this but order patterns in Q1 show encouraging trends in volume and mix. Latin America had an excellent first quarter growing more than 40% off a small base compared to Q1 of last year. Automotive, ag, infrastructure and natural resources markets continue to be very healthy.

In terms of outlook going forward comparisons become more difficult. We expect the quarter over prior quarter prior year quarter's growth percentages to decline as we are approaching, and in many cases exceed our pre-recession peaks. We expect global Industrial market conditions continue to be favorable for us this year, and we are particularly positive on the developing economies. Our investments in new products, new markets, and new distribution offer ample opportunities for growth.

We remain cautious about our base business prospects in the US Contractor equipment market. However, our investments in new products and channel give us an opportunity for success in 2011 even with weak end market conditions. We expect the European and Asian Contractor business will continue to perform well. This concludes my prepared remarks. I now ask the operator to open the session to Q&A.

Thank you, sir. (Operator Instructions). Our first question comes from Christopher Wiggins from Oppenheimer please proceed with your question.

Hi, good morning.

Good morning.

Great quarter. The first question I had could you just -- how much of the growth in the Contractor year-over-year was from the new product stocking into the home center channel?

Well, we expect that the new product -- excuse me -- the stocking into the home center channel in total was about $5 million and we are estimating that about 25% to 30% of it was the hand held item.

Okay. Great. Thank you. And then I guess across the segments could you comment a little bit on where your utilization stands rights now and I guess I'm wondering how much absorption is left to capture as you kind of go through the rest the year.

At this point we think our factories are pretty much back to the volumes that we were expecting to fully absorb our fixed manufacturing costs.

Okay. Great. Thank you. And then the last question I guess on Industrial in particular it doesn't look like there was any mix benefit in the quarter. So I mean is this kind of the new type of margin levels that you think is indicative to this type of volume? And I guess the bigger question then becomes, is there any risk that customers see this kind of margin level and might push back a little bit you know as far as concerns over whether you're making too much money off of them?

Well, I will answer the equation question first. For sure we think this is a great operating performance. It's operating at the factories that we do have some material cost pressures coming forward, but we also have some favorable trends on the efficiency and productivity side as well so we don't see that as a large headwind but something we should mention. With respect to the end-users we price for our intellectual property, we price for our features that we offer versus the competitors and we don't see any pressures back from the field. People like our products because of the ROI they get from using it saving material and labor and we are very comfortable with where we are at price wise with respect to competition.

Great. Thank you. I'll get back in the queue again. Great quarter.

Thank you. Our next question comes from Terry Darling from Goldman Sachs. Please proceed with your question.

Thanks and good morning.

Morning.

Hey, Pat, I think you had indicated, though, you on the Contractor home center stock you expected that to continue all year. Can you elaborate on that? And then I'm wondering if you might address what you think was going on from the stand point of just the seasonal kind of Q1 inventory build that sometimes happens it did seem across the Industrial space that people working inventories down very hard at the end of the last year and maybe there would be some normalization that would happen in the first half. Let's start with those two.

Okay. On the Contractor side no, the inventory stocking in the home center channel will not continue all year. What's going to happen is that we have got more outlets in the balance of the year than we last year which will be helpful. We picked up 800 or 900 additional outlets, and so now that those are stocked up our run rate will have some hopefully some tailwind because of that through 2011. So I think that's positive for us. On the question --

Sorry. I'm sorry. Just to be clear on that, Pat, so you are saying that $5 million is a good run rate but you are not going to build from that is that what you mean.

No. $5 million is what the load was in the first quarter. So we end up with expansion in the home center we have to fill up some stores with more product and we have to fill up 900 stores with the full product line and that got us $5 million. Now instead of having at one particular account instead of half their stores in 2011 we have got all their stores for the balance of 2011. So I'm not making a prediction on what the run rate is going to be. I'm just going to say that we have got a lot more outlets in the last nine months of 2011 than we did the in last nine month of 2010.

Okay.

What the run rate will be we will see now that we are stocked up, but it should be good. Back to your other question regarding inventory build, I don't really see any signs that inventory build either in our channel or at the end user had any significant impact on Graco in Q1. Our Industrial channel partners typically stock only what they need to service the spare part needs of the customers. Graco's business model is to maintain a significant inventory of finished goods and to ship it out typically in 24 hours notice and so big inventory swings don't happen much in our Industrial business and I don't think we saw any of that in the first quarter.

Okay. And in terms of the what you often see in terms of a significant step up in margins in Contractor Q1 to Q2 anything different about either this year in of itself or where we are in the cycle that would change that normal seasonal pattern in Contractor margins?

I don't see any reason to give anything different, different prediction for this year.

Okay. And then, maybe on the -- across the -- well, first on the lube margins coming off a little bit here what was the main reason for those stronger margins than what you were expecting over the balance of the year for lube? Was that just a particularly good quarter in Europe or something like that or?

We had a couple of little one times that helped them, otherwise they would have been in that 18%, 19% kind of a range and that's really where we expected them to be this year was in the high teens. We continue to invest in our Industrial lube initiative for growth and we continue to put a fair amount of resources into Europe and Asia where we are seeing some nice growth in lube so we are making sure we are doing the right things to grow the top line. We are expecting operating margins in the high teens, and they just had a couple of blips that helped them in the first quarter.

Okay. And one more and then I will get out here. Jim, I wonder if you could help us with what if we held Euro dollar constant from here forward, what you think the translation effect would be on a full year basis 2011 year-over-year on EPS or revenue or however you can help us with that?

Well, it's a question that comes up from time to time and I don't give point estimates with respect to it. I do indicate that last year in the second quarter the Euro rate was 128. Today it's 148. So we will have some margin expansion from the Euro. You recall that the Euro represents about 16% of our volume. Another few percentage points coming from the Pound Sterling, so it is a significant tailwind for us in the second quarter.

Okay. Thanks very much.

Thank you. Our next question comes from Charles Brady from BMO Capital Markets. Please proceed with your question.

Good morning. This is actually Tom Brenton standing in for Charles Brady. Just a couple of questions. The -- also, the absolute level of the backlog you guys had. You talked about how it's up $6 million quarter-over-quarter.

Correct.

That's correct.

Right. Can you give us some context there, what was the absolute level of the overall backlog?

Sure. I've got that here. So our backlog is about $49 million at the current quarter end versus $42 million, $43 million at the end of the year. A nice increase in Contractor and in the Industrial segments offset by a small decline in the Lubrication segment.

Okay. Great. And can you talk about the material cost pressures, can you quantify what the head winds are going to be that you expect to be able to offset but are you talking about a hundred basis, couple hundred basis points there the remainder the year.

I would say that's general category for reduction in gross margins is in that 100 basis points to 150 basis points. Before any of the other parts of the equation come into play. Again, the higher productivity and efficiencies our factories are achieving as we exceed our or meet our capacity targets plus some additional pricing that will roll through in the second and third quarter.

Okay. Great. That's nice color. And then as far as the acquisition of the ITW businesses is it fair to say that I guess your opportunity to expand margins there is pretty much based on new product introductions? You mentioned earlier in the call how you have intellectual property and your ability to differentiate products from your competitors. Is that pretty much you're hoping to add as opposed to you know selling synergies or operating cost synergies?

I would say that our margin expansion from the ITW acquisition will come -- opportunity will come in the manufacturing intellectual property mainly a conversion from buy to make in the piece part that they acquire. We'll get some cross-selling synergies but they're not significant.

Okay. And then last question can you give us some guidance on the tax rate going forward?

Yes. Full year should be in the 34% range.

Okay. Thank you very much.

We shouldn't have the volatility which we have had in the previous years with the government putting the R&D credit in and out and the domestic production deduction credit -- or deduction is fully in place now so we should be good for the year.

Great. That's very helpful.

Thank you. Our next question comes from Matt Summerville from KeyBanc. Please proceed with your question.

Morning. Just a couple questions on the Contractor business. You talk about having more product in more stores then you have a little bit of a tail off from the initial stock end with Truecoat and ProShot. I guess the net of those two how should we think about the top line trajectory in Contractor? Can you give us a little more granularity about the right way to think about that as we move through the remaining three quarters and maybe also layer in there your view on whether or not those customers will add back a meaningful amount of inventory of what I'll call your, for lack of a better term, more of your legacy product?

Okay. Yes. I can make a couple of comments. First as Caroline mentioned in her comments we anticipate that Contractors more likely to look more normal from a seasonal selling standpoint then maybe it has the last couple of three years when things have been a little bit kind of up and down. So our view is if you are looking for trends in Contractor you best off predicting sort of a normal seasonal curve which would bode well for our outlook for the second quarter. We like the new products that we have launched for 2011. We do have to overcome the load that we had in the second quarter of last year with the hand held which was about $9 million, but we believe that's doable based upon the new product that we have and the fact that we will have some sell-through as well. So in general, I think we are feeling better about our Contractor business despite not great end market conditions.

The other interesting thing that we saw here in Q1 was is that our -- I'll call it our base business, our legacy product, our large gas sprayers and our large electric sprayers that really were meat and potatoes of our business during good times, they really died from 2007 through last year and we are seeing some interesting signs of life in those product categories in the first three months of the year and we are seeing a mix that looks more normal. And we -- the last four or five years the mix has really shifted towards the low end part of the line. We think that was people being price sensitive and we think it was also related to the big amount of sprayers that were sitting out there in the market when the housing market stopped. Again, it's a short data point and I like to get some more months behind us but our view right now is that potentially the inventory that's out there in the channel has been soaked up since 2007 and we may see order patterns on our high end Contractor equipment start to look more normal as well as a more normal seasonal pattern, and all those things would be good for both volume and profitability for Contractor going forward. So I think there's some slight reasons to be optimistic over and above the fact that we have got some interesting new product and that we have got additional channel.

With regards to the $9 million you mentioned for Q2 do you have the figure for Q3 as well because I thought that original stock in had a pretty profound impact on both quarters last year?

Actually Q3 was about $12 million and I believe Q4 was about $5 million to $6million.

And do you think, again based on sort of the data points you just shared, do you think growing above and beyond that are backfilling maybe is the better way to term it do you feel comfortable about more than backfilling in Q3 and Q4 as well?

Well, I never feel comfortable about anything because it's not my nature. I don't think it's begun to be like falling off a log but we do have good product that we are launching this year. We did sell about $8 million of hand held in the first quarter. Now, just for full disclosure a chunk of that went into the home center load which Jim talked about was probably in the $1.5 million to $2 million and then we also is have another version that we launch that we to the play on but we are still seeing revenue on that product line and I think that we have an opportunity to grow here over the course of the summer.

As these new product launch support costs ad campaign is that either tails off a little bit in aggregate that expense how should we think about the incremental in this business relative to Q1? You're at 32% as I'm sure you know in the first quarter. How should we think about those incrementals moving forward given some of the dynamics we are talking about here?

Well, Matt, we are forecasting our seasonal trends to return in the Contractor business our first and fourth quarters are always or lowest profitability. You saw the 16% we had in the first quarter so the seasonal pattern will drive that higher on a normal basis and then, again, we should see a flattening if not an absolute decline in the store set expense in the second quarter and then of course by the third quarter that's over. So you can expect and you can model that our Contractor operating profitability will increase in the second and third quarter.

Thanks, Pat. Thanks, Jim.

Thank you. (Operator Instructions). If there are no further questions I will now turn the conference over to Pat McHale.

Alright. Thanks everybody for their time this morning and have a good rest of your week.

This concludes our conference for today. Thanks for participating and have a nice day. All participants may now disconnect.