Graco Inc (GGG) 2011 Q4 法說會逐字稿

Good morning, and welcome to the fourth quarter and year-end 2011 conference call for Graco Inc. Please note it is not Graco Incorporated. If you wish to access the replay for this call, you may do so by dialing 1-800-406-7325 within the United States or Canada. The dial in number for international callers is 303-590-3030. The conference ID number is 4502375. The replay will be available through February 4th, 2012.

Graco has additional information available in a PowerPoint slide presentation, which is available as part of the webcast player. 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 as to their expectations, plans and prospects for the future. These remarks constitute forward-looking statements for the purposes of the Safe Harbor Provisions of the Private Securities Litigation Reform Act.

Actual results may differ materially from those indicated as a result of various risk factors, including those identified in Item 1A of Exhibit 99 to the Company's 2010 Annual Report on Form 10-K, and in Item 1A of the Company's most recent quarterly report on Form 10-Q. 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 of the time they are made. The Company undertakes no obligation to update the statements in light of new information or future events.

Later on in today's presentation we will have a question-and-answer session, and at that time instructions will be given.

I would now like to turn the conference over to Caroline Chambers, Vice President and Controller. Please go ahead.

Good morning, everyone. I am here this morning with Pat McHale, Jim Graner, and Christian Rothe. I will provide some comments on the financial highlights of our fourth quarter, and Pat will follow with 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 and each of the segments. After our opening comments, we will open up the call for your questions.

Sales for the quarter were 9% higher than the strong fourth quarter last year, which included 14 weeks as compared to 13 weeks in 2011. Translation rates did not have a significant impact in the quarter. Sales for the year increased by 20%, or 18% at consistent translation rates, with strong growth in all the segments and regions.

Although changes in currency translation rates had no effect in the fourth quarter the full year affect increased earnings by $7 million after tax. Additional information about effective currency translation on sales for the segments and regions, as well as sales by currency are included on page five in the slides that accompany this webcast.

Gross profit margins were 54% for the quarter consistent with the prior year, and 56% for the year, an improvement of 2 percentage points from the prior year. Material costs increased in the second half of the year, largely offset by improved factory efficiencies.

Operating expenses in the fourth quarter were flat compared to last year. For the year the increase of $30 million from the prior year includes additional product development spending, continued development of commercial and support capabilities in developing geographies, and increased general and administrative expenses.

Operating expenses also include $8 million in 2011 related to the proposed acquisition of ITW's finishing businesses. Interest expense was $4 million for the quarter and $9 million for the year.

Effective tax rate for the quarter was 30% compared to 26% for the quarter last year. In 2010 the effective rate for the quarter was low because the federal R&D tax credit was not renewed until the fourth quarter, and the full year effect was included in that quarter. The lower 2011 fourth quarter rate compared to the 2011 annual rate is due to higher estimates for the domestic production deductions and R&D credits, as compared to earlier in the year.

Year-to-date cash flow from operations was $162 million compared to $101 million last year. Inventories and Accounts Receivable leveled off in the second half of 2011, after increases in the first half related to increased business volume. Capital expenditures were $24 million in 2011 and we also paid dividends of $51 million. We repurchased $43 million of Company stock during the year.

Cash of $300 million at year-end is held in deposit account and money market funds. Long-term debt is $300 million, with an additional $264 million of unused credit lines available at year-end. Our net liability for retirement benefits and deferred compensation increased to $120 million at the end of 2011, as compared to $76 million last year, primarily due to the very low discount rates at year-end.

A few other items to note, we expect to see material cost pressures continue into 2012. Even as some commodities moderate, other materials continue to see upward pressure.

We have a robust plan for factory efficiencies that will be implemented during 2012. Factory production levels are expected to be in line with sales growth going forward. Although we expect costs overall to be consistent for the full year 2012, we do expect an increase of cost of 1% to 2% in the first quarter comparison.

Our annual price increase has been implemented and we expect to begin to see the impact in the first quarter with full year expected price realization of 3%.

Expenses associated with the proposed acquisition are expected to be in the range of $4 million to $6 million in the first quarter, as we support the cost of litigation to gain approval for this transaction. We expect an increase of approximately $5 million in pension expense in 2012, and are considering an additional contribution of $10 million to $20 million to our funded pension plan.

2012 capital expenditures are expected to be in the range of $30 million. And at this point, an extension of federal R&D tax credit has not yet been passed by Congress, and we expect annualized tax rates to be approximately 34%.

With that, I will turn the call over to Pat.

Thank you, Caroline. Good morning, everyone. As we start I want to take a moment to thank our employees, our distributor partners, and our end users for a great 2011. We achieved record sales for the year, and our 2011 diluted EPS returned to the peak. Well done, I appreciate your efforts.

Before we get into the details of the quarter, I want to underscore for our investors there was one less week in the fourth quarter and full year 2011 than there was in the same periods in 2010. We called this out at the end of Q3, and I am going reference it several times today.

You will hear in many of my comments figures that compare average weekly sales from Q4 2010 to Q4 2011. This removes the comparison issues with the additional week in 2010, and I believe is more insightful regarding our business tempo. Even when adjusting for the extra week, there was a slowing of growth rate sequentially from the third quarter to the fourth quarter. This is not entirely surprising given the strong double-digit figures we posted throughout 2011, as well as the headlines on the Eurozone sovereign debt crisis, the potentially slowing growth rates in China, and the ongoing overhang in worldwide construction. The fourth quarter was still strong. It is just that the growth moderated somewhat.

We posted our eighth consecutive quarter of double-digit growth in average weekly shipments, 18% year-over-year.

For the quarter we had a few expense headwinds compared to the fourth quarter of 2010, including $2 million of acquisition-related costs, $3 million of additional interest costs on borrowings used that will be used to fund the acquisition, and a tax rate that was 4 percentage points higher than last year. All told these costs were $5 million after-tax headwind on net income.

Material costs, which we were expecting to moderate in the fourth quarter, continued to put downward pressure on our margins throughout the quarter. While these costs are currently stable, we are actively working on cost reduction initiatives as part of our annual drive for zero cost change in our factories.

Now let's go through each of our divisions and regions starting with the Contractor segment. Worldwide sales in this segment were up 1% in Q4 versus the prior year. On an average weekly sales basis, the segment grew 8%.

In North America, the Pro Paint channel was up 18%, and average weekly sales for the quarter reflecting the continued strength that we have seen in this channel throughout all of last year. This strength had been somewhat masked during the year due to the difficult 2010 comps that included the store load of the handheld products.

The fourth quarter didn't have that problem. Average weekly sales for the Home Center business in North America was up 14%. In Europe contractors struggled in the fourth quarter with sales down 15%. While this is disappointing the decline in the underlying business tempo is not as extreme as it appears.

Europe had a later launch of the handheld product line in 2010 and the fourth quarter of 2010 included $4 million of handheld sales that were associated with store loads. When converted to average weekly sales and removing the handheld comp, the contractor segment in Europe actually grew modestly.

That said I am generally cautious on my outlook for Contractor Europe, particularly over the next couple of quarters for achieving growth over prior year will be challenging.

In Asia Pacific Contractor average weekly sales were up double digits in the fourth quarter. We've got some exciting new products that we are launching in contractor this year including an extension of our handheld line, that can apply protective coatings, innovations in our line striping category, including a stand up ride on unit, and more products in development for a second half 2012 launch.

We remain focused on converting end users from manual application methods to using spray equipment particularly in the emerging markets, and will continue to invest as opportunities warrant.

While our North America Contractor business will continue to be challenged by depressed new construction levels, we intend to stick to our strategies and investments. When the US market tanked at the end of 2006, we made a decision not to right-size this business. Instead we have continued to provide high levels of support to our distributor partners, innovate our product offering, and compete hard for new business. Operating margins in this segment have suffered, but we are confident that as base business volume returns we will have good leverage.

[When construction markets] normalize I expect this business will return to the mid-20s operating margins and we will be a more able competitor as a result of our continued investment during the downturn.

Moving on to the Industrial segment, the fourth quarter was another strong quarter for our Industrial segment across all geographies and product lines. On an average weekly sales basis, sales in Europe and North America grew in the mid-teens while Asia Pacific grew at 29% compared to the prior year. This was the highest quarterly revenue ever recorded in industrial for any fourth quarter in the Company's history.

From an end market perspective, we are seeing favorable growth trends with automotive, energy, mining, ag, and general industrial, all generating above trend activity levels. Operating margins were strong in this segment, and we are positioned well for more growth in 2012.

Now for the Lube segment. During Q4 sales continued to grow at a strong rate with solid double-digit increases in North America and Europe. On an average weekly sales basis, growth in Asia Pacific was outstanding at 71%.

Operating margins continued to improve in Lubrication as well. We exited the year at 19% right on plan with our stated goal of the high teens. Looking to 2012, we expect that operating margins will expand into the low 20s. Ultimately we believe that this business can perform in the mid-20s, although we are still a few years away from that goal.

We are seeing strong activity for vehicle services, both domestically and abroad, and we continue to gain traction in our Industrial Lubrication initiatives, with recent wins in renewable energy applications, as well as other traditional and on board Lubrication systems. As you know, we have invested significantly in this business in the recent past, adding resources to grow our channels to market around the world, and new product development initiatives. We made further investments into our plant in late 2011, and will continue those investments into 2012.

As the equipment comes online we will gain efficiencies in our plant which should improve our operating margins. We still see outstanding opportunities to grow our Lubrication segment into 2012 and beyond. It is a big market and we are just scratching the surface. I am pleased with the great progress the entire [LED] team has made over the past two years.

Now for Europe. Q4 sales in Europe were flat last year. Looking at it from an average weekly booking rate, however, the region grew 7% from the prior period, with growth in the mid-teens for Industrial, 26% for Lube, but down 9% for Contractor.

As stated in the Contractor discussion earlier there were $4 million of handheld sales in the fourth quarter of 2010 related to our launch of that line in Europe. Without that difficult comp we would have posted a modest increase. That being said, there is no doubt that the overhang of the Eurozone sovereign debt crisis, as well as economic weakness in the developed countries of Western Europe is having an impact.

There are bright spots. Automotive has been strong of late with some nice wins with major European auto manufacturers. Our Lubrication business is doing very well, plus renewable energy in Eastern Europe are contributing. On an average weekly sales basis, Eastern Europe grew at a rate in the high-teens during the fourth quarter.

Moving to Asia Pacific, our businesses in Asia Pacific all had a strong quarter, with each segment posting double-digit growth and average weekly sales, plus every segment also achieved new peak sales figures for any fourth quarter in the Company's history. The team in Asia Pacific has done a tremendous job since 2006, Graco's business in Asia Pacific has nearly doubled.

Before I get on to our outlook, I want to briefly discuss our litigation with the Federal Trade Commission, which is trying to block our acquisition of the Finishing Brands from ITW. We patently disagree with the FTC's position that this deal is anti-competitive, and we are fully prepared to lay out the facts in court.

Beyond the facts of this case, which I believe support our position, I am personally disappointed to be fighting our own government on this transaction. Graco is a shining example of a US manufacturing company competing successfully in a highly competitive global market place. While less than half of our sales are in the US, more than 90% of our manufacturing is here. We invest heavily in state-of-the-art technology, and we provide a reliable and growing base of well-paying jobs and tax revenue.

I see this transaction as consistent with the strategic goals outlined by President Obama on many occasions. Approval of this transaction will expand our capabilities and allow us to more successfully compete against the many non-US players we face here at home and around the globe. We will continue to press forward.

In terms of outlook, we are planning for growth in 2012. Certainly there are a number of headwinds that we will be facing, including continued economic uncertainty in Europe, and a construction market that will remain challenging. As is always the case with Graco, we don't just take what the market gives us.

Each of our segments have a plan of attack for 2012, it has us taking share, entering new market segments, increasing our presence in emerging markets, growing our distribution in both developed and emerging markets, converting end users from manual paint application methods to using spray equipment and launching new products to keep us ahead of the competition.

While we have a strong history of executing against these strategies, we do have difficult comps from our record year in 2011. This is particularly true in the first quarter where we had very strong results in all of our segments in 2011.

Nonetheless, we are expecting growth, and we're off to a good start. Incoming orders for the first four weeks of this year have been solid in all segments and geographies.

From the margin perspective, I am expecting that we will grow margins sequentially from the fourth quarter. New pricing took effect on January 1 in both the Americas and Europe, and will take effect on February 1 in Asia Pacific.

We have new equipment coming online that should improve factory efficiencies this year and the cost reduction projects as I mentioned earlier. We have the right strategy and the right team. I am pleased with our performance in 2011, and I am excited about the opportunities we have for 2012.

Operator, we are ready for questions.

Thank you. (Operator Instructions). Your question will be taken in the order it is received. Our first question comes from the line of Charlie Brady. Please state your question.

Thanks. Good morning, guys.

Good morning, Charlie.

Can we just get a little more granular on some of the growth expectations and the incoming order rate? When you talk about slowing growth, are you referring to comparing that to Q4 growth rate, or all of 2011 or something else?

Charlie, this is Jim. As Pat said, we are looking forward to a good year in 2012. The first quarter comparison will give us some difficulty especially in the Contractor area. If you can recall last year we had an initial store load that we're estimating about $6 million with one major US chain. That store load will give us a tough comp for the quarter, as well as the comments that Pat made about the Contractor in Europe.

With that we are looking for a flattish revenue number to slightly positive in the first quarter worldwide, but we should see an improvement in our operating margins as approximately $3 million in store load costs we incurred last year first quarter won't reoccur in 2012.

Regarding Europe we are looking at single-digit growth again quarter-to-quarter, first to first, as Europe struggles in the construction. We are expecting very little help from southern Europe. Northern Europe looks okay. The incoming order rate there is in the double-digit, so again we are confident at this point in forecasting growth there in Europe in the low-single digits.

Given that we are still expecting Asia Pacific and Latin America to grow in double-digits, as well as our worldwide Industrial and Lube segments.

So just so I am clear, for Industrial and Lube for the year, would you expect those both to grow double-digits?

Yes, that is our current plans.

Okay, that is fine. With regard to the acquisition expense the $4 million to $6 million in Q1, can you help us out beyond Q1 what your expectation is for expense beyond that for the full year maybe?

We haven't gotten there. Currently our expectation is that the litigation will start and complete in the first quarter, and in that range that Caroline threw out of $4 million to $6 million that expects the start and completion in the first quarter. And of course if we win we should start to execute on the acquisition.

One more and I will hop back in the queue here. On your commentary on the material cost headwinds, can you give us a sense just on that piece of it, how much of a headwind to margin that was in the quarter?

It is less than 1 full percentage point, what we did see I think we called out in the third quarter that we did expect a moderation in the cost of the metals. We did see that. We had some surprises though on some other material costs that offset the reduction in the metal kind of area. But in total it was less than 1 full percentage point, closer to three-quarters of 1%.

Thank you.

Thank you. And our next question comes from the line of Kevin Maczka with BB&T Capital Markets. Please go ahead.

Good morning.

Hi, Kevin.

Pat, you are back to record revenue now. You are increasing CapEx a bit in 2012. Can you just talk about utilizations by segment? Are you capacity constrained anywhere? And where do you need to spend the money to expand that capacity?

Well, we have two major processes that we do internal to our factories, and one is machining, where we take the raw material, the bar stock and the castings, and we turn that into precision parts, and then the other is our assembly area.

From a machining standpoint, generally we are fairly well utilized, on our machining equipment, it is hard to justify new equipment unless you've got a fair amount of load to put on it. So I would say that going forward in 2012, we are, I would say, sort of a fairly normal position from the machine utilization, and as we grow we will continue to add machines like we do every year.

From an assembly and from brick and mortar standpoint, the evaluation gets a little bit more complex. We can take a lot of growth in our existing product line within assembly lines and the space that we have. As we get new products that launch, they have to have their own assembly lines is where we start to push the boundaries a bit on brick and mortar.

I would say our factories are pretty full right now in the $30 million number. We do not in that $30 million there is not an expectation that we will do a brick and mortar project.

Okay. Incremental margins, I wanted to ask a question there. You broke that out nicely, 44% even higher if we back out the ITW acquisition. Generally should we be expecting something similar next year? And can we just talk about this pension expense a little bit more? Because that looks like that will be quite a drag potentially?

There is no reason, Kevin, that we shouldn't achieve the 44% incremental margin if we get the kind of growth rates we talked about a few minutes ago. The pension cost is an incremental $5 million. So if you compare that to a $900 million revenue number, it is less than 1% of sales. It is an impact, I think all corporations are feeling the pain of the ever-decreasing long-term interest rates and the lower discount rate that Carolyn talked about.

So we are fully allocated to equities. We're at about 80% of our assets in equities, so we are fully leveraged to what I expect to be a more positive equity market in 2012. And if that happens that will diminish the need to put more funds into the plan.

Right, Jim. The $5 million is relatively minor. But in you slide it may be as much as $25 million. What would be the delta or what would trigger that?

The $5 million is what we expect to see running through the P&L. What we might need is the need, as Jim referenced, to contribute some additional cash into the plan. Part of that will really depend on what we see for asset growth during the coming year. So the difference between the cash contribution expectation, a possible expectation there as compared to what will run through the P&L.

Got it. Two more quick ones from me. Are you ramping product development spending again in 2012? And was that 3% price increase across the board?

On the product development side, we may do a little bit, but it is not going to be a dramatic step function increase. In terms of pricing, we do our pricing by product line, and by region, and by category, so that is an aggregate number of all of the different areas.

Got it. Thank you.

Thank you. And our next question comes from the line of John Franzreb with Sidoti & Company. Please state your question.

Good morning, guys. Could you talk a little about the roadmap to growth in Europe? It sounds like you are allowing for some slowing growth in Contractor Europe, with both coming out of Lube and Industrial. Is that the case, and is there more needed for you to have year-over-year growth in that business over there?

Well, of course there has been a lot of uncertainty in the headlines since the summertime period, but what we are trying to communicate really, is that through the fourth quarter and even up to the beginning of this year, we have continued to see pretty good demand on the Industrial and Lube side of the business. Where we are having most of the impact is on Contractor.

Certainly even within Industrial, there are areas that are stronger and weaker, and I think Jim pointed those out to you, where the North is doing better and the South is not doing very well. For Graco it is EMEA, so it includes Eastern Europe, Russia, the Middle East, and parts of Africa. We believe that despite the fact there's going to be some challenges in our Contractor business in 2012, there are ample opportunities for us to continue to grow other segments of our business within that reporting region.

Great, that was helpful. And the margin profile is improving incredibly in the Lube business, and you have kind of laid out a formula that will go to the low-20s next year and mid-20s sometime thereafter, you've talked about investments, can you provide a little color as to what kind of investments we are talking about here? Is there some sort of end markets that outperforming others, or is there some sort of process that -- improvements that are more important to get you that kind of margin profile? A little color will be helpful.

So, you know we were there back before we did all the acquisitions and moved all of the factories, so we do have a history. We also have a view that the businesses that we acquired, underling nature of those businesses is not less attractive from a margin standpoint than historical business that we had.

It's been a challenge for that group, shutting down three factories associated with the acquisitions, and moving the Minneapolis business all into a new factory, and then trying to get the product lines reengineered to, I'll say, Graco standards, and get some product differentiation.

So, we've been confident during this, I guess what you'd call swoon in our Lubrication operating margins, that we were going to return to our historical place in the mid-20s, and for the last couple of years they have really been doing that on schedule.

The opportunity in Lube for Graco isn't necessarily just a particular end market. The way I really view it is is that we are going to make investments in our distribution channel and our sales coverage outside the US, where we have small share, and there is a lot going on. And then in the US is where our major product development is. Not all of it, we have some in China, but in the US is the big chunk of it. And we're going to continue to invest in making sure our product is differentiated.

From an operating margin standpoint, the factory is still not performing up to what we believe that it can do. They have justified a lot of new capital that showed up beginning in second half, particularly in the fourth quarter of 2011, and so we think we have got some nice improvements that we are going to have going through the factory in 2012 that will also contribute to the operating earnings.

We expect to see leverage on the top line, we expect to see better factory performance and investments related to people, channel, and new product.

Perfect. And lastly, should the IT deal go against you, have you guys thought about or articulated a Plan B for us to think about out there?

We have not articulated anything else other than that at this time, John. We are still focused on this transaction, and all our efforts are on completing this transaction.

And also remind everybody that we've made the decision to put the long-term debt in place of the $300 million before we actually had the ITW deal. And we believe from a strategy standpoint that interest rates were historically low, and locking in some long-term debt those low rates would be beneficial to our shareholders.

And so we are confident that outside of the ITW acquisition, we've got enough opportunities to invest and to grow, that we can put that money to good use.

Thanks, Pat and Jim.

Thank you. And our next question comes from the line of Matt Summerville with KeyBanc.

Morning. A couple questions. First, are you able to provide an update as to the performance of the ITW finishing businesses, given that those guys are out reporting today as well, versus kind of the expectations that you had laid out for those businesses back in March or April, whenever this transaction was originally announced? Is there any updates you can provide us to those numbers?

Matt, I don't want to get back into specifics, but we would say that that business is performing like our industrial business, and they are close to their peak that they had that we announced back at the time.

And then with regards to the handheld products in Contractor, you have added around that product line a little bit already with fine finishing. Now you are moving more into, I think you indicated other types of materials that you are looking to put through those devices. How big is that handheld business for Graco now? And I guess what can these new products add incrementally to that platform?

So it's been a little volatile with the store load. This year we ended about $20 million down from the $28 million we had last year. We do have some products scheduled to launch in 2012. But at the present we are still thinking in the $20 million range on an annual basis. It is down from where we were a couple years ago, which at that time we were forecasting much higher volumes than we are today.

And then with regards to corporate expense and bearing in mind pension, what sort of numbers should we be using for 2012, and just for the purposes of this discussion, let's exclude the transaction costs which I mean, you really can't predict beyond the first quarter anyway, so let's exclude that. What should the ongoing rate of Graco's corporate expense look like, Jim?

I would expect that the pension expense would grow by the $5 million referenced earlier. And if you exclude the ITW numbers it should stay fairly consistent with 2011, plus the $5 million in 2012.

So the pension does hit the corporate expense line?

Correct.

Okay. And then with regards to the fourth quarter if you back out the ITW transaction costs, it looked like your corporate expense run rate did come down a bit. Is --- was there some adjustment there, or is that kind of the right run rate to think about?

The only thing that we didn't do in the fourth quarter, Matt, was make the contribution to the Graco Foundation. So the full year of the foundation contribution was $3 million, all of which was made in the first three quarters. Other than that there is nothing significant in the fourth quarter.

Got it. Thank you.

Thank you. And our next question comes from the line of Terry Darling with Goldman Sachs. Please state your question.

Thanks, good morning, everybody.

Good morning, Terry.

I guess a couple of follow-ups on a number of items. First, on maybe a finer point on first quarter organic growth. Pat, given your comment about solid double-digit weekly orders here through the first four weeks, and if you go back and adjust for the week's issue in the fourth quarter, and then sprinkle in Jim's more precise commentary on Contractor, does organic for the entire Company get into the low double-digits for the first quarter? Is that the translation?

I will make a couple of comments for you, Terry. First of all, I didn't give any specific order run rates for the first four weeks of the year. My comments were that we had double-digit run rate through the fourth quarter.

Thank you.

The first four weeks of the year we were off to a good start. I really don't want to get into trying to make fine estimates in terms of what our organic growth rate is going to be in the first quarter. Primarily because as you know we have a short cycle business, and it is pretty spread geographically.

Can we perhaps though put maybe a finer point on the full year commentary of double-digit organic for the Company, on the segment side, is it fair to put Lube in, call it the strong double-digits, and Industrial in the low double-digits at least, is that fair?

I think you are going to have to do your own numbers.

And then maybe we will follow-up on your comments, Pat, on contractor margins getting back to the mid-20s. Revenue for this year just under $300 million. I think if you go back to the period when you last had mid-20 margins in Contractor, you were just over $300 million. I guess the question is what level of volume do you need to see, in order to get back to that level? Or is it more complicated equation, based on mix and those sorts of things?

Let me take a stab at it, and then Jim can jump in if he wants. When you take a look at the current revenue that we have in Contractor by product family, it looks a lot different than it did back in 2006. It has been a really terrible environment for that division to try to grow, and yet they have been eeking out some pretty consistent double-digit gains. That has primarily been with new products and with new initiatives.

So the underlying base business particularly in North America, but to some extent in southern Europe, on our, I'll say our core everyday bread and butter products, is down by tens of millions of dollars from where it was back in the 2004 to 2006 time frame.

From my standpoint, we really need to see that base business continue to rebound. Again we did see it starting to come back in 2011 for the first time, which was nice. But we really need to get that revenue back in order to drive our profitability up. The assembly lines are sitting there the machines are there, we know how to make the product. It tends to be our higher margin Pro product. And that is going to be really important in driving that improvement in operating margins.

If we get our growth through new products, or primarily get our growth through new products in the course of the next year, then I would expect that we would see operating margin leverage that is more in line with what we've seen in the last couple years, and not the snapback that I expect to get when we see the end markets get better.

From my perspective, a normal housing market in the US is somewhere around 1.5 million units. We get back to 1.5 million housing starts, I think that the operating margins in our Contractor North America business are going to start to look pretty nice again.

And, Jim, you can jump in if you want.

I'll just, Terry, just echo Pat's comments, it does take that next change to come into the equation. We are geared to do that. Our market position is as strong as it's ever been. We have a few new products that are being launched in the second quarter. So we see an incremental march back to the mid-20s. It won't happen in 2012, but maybe by 2014 hopefully if we see some improvement here and in western Europe with respect to construction.

And just to be clear, Pat, if the growth is coming from new products, you have growth and profit in line with what we've seen in recent years, or margins are about where they are now?

No, I think we'd see incremental operating margins in line with what the incremental operating margins have been given what was coming from new product.

Okay. And then maybe it would be helpful for folks if we could get a little bit of a break out within your European business. You have called out emerging market Europe. What is that as a percentage of total Europe at this point?

Emerging markets is about one-third of what we report under the Europe, and two-thirds is what we refer to as Western Europe.

And can you tell us what that emerging Europe piece grew in the fourth quarter as we calibrate the pieces of the puzzle here?

In the high-teens.

And then lastly on Asia, Pat, I wonder if you could provide a little more color there. We saw a pretty good deceleration at the Company level overall. Still very healthy, above 20% with a lot of that reflected in the results of a number of other companies in the China area in particular. I think most people are looking for kind of a similar, slow type of environment in Q1, and then a rebound.

But I wonder if you might add some color from what you guys are seeing?

You have got to remember too when you look at our fourth quarter, we had the same 13 versus 14 issue in Asia that we had everywhere else, which would have tacked on some more growth there.

In general, feeling pretty good about what is happening over there. There are some areas of watch out I guess from an economic perspective. But we've been investing a lot, we put a nice new training center in place in June. We've got new products launching over there, the team is getting better every month. So I think the building blocks for Graco in Asia Pacific look pretty solid.

I think as long as something dramatic doesn't happen over there, our ability to get nice growth in 2012 stays intact. They have been putting up some really big numbers. It is hard to predict whether those kinds of big numbers are going to continue, but we definitely feel confident that they can do double-digit kind of numbers in 2012.

Sorry trying to squeak one more in here. Jim, I think I heard the tax rate guidance 34%, that does not include an assumption of an R&D tax credit reup. Would you be in a similar zone in 2012 versus 2011 if that did come through at the end of the year?

We would. And for your equations, R&D credit for Graco represents about a $3 million in tax savings, so --- again it depends on where you are modeling the earnings, but it is $3 million in cash and lower tax rate.

Thanks very much.

Thank you. And our next question comes from the line of Mike Halloran with Robert Baird. Please state your question.

Good morning, everyone.

Good morning, Mike.

So just a point of clarification on Jim's more granular comments, when you were referring to kind of flattish revenue and up, and a little bit better on the margin line, were you specifically referring to the Contractor piece?

Yes, only the Contractor.

Only the Contractor piece. Okay, that makes sense. On the industrial margins specifically, still great margins, just wondering at the revenue level you saw fourth quarter versus third quarter, lower margins sequentially off of that? Is that just a function of some of the commodity costs you mentioned maybe some incentive comp differences and things like that, or maybe just a little more granularity there?

It's mainly one point of that is the cost pressures in the equation. And as we talked about before, we have pricing in 2012 that should offset those cost pressures, and then the other piece is a little bit on the exchange rate.

Okay. And so when I think about margins on a sequential basis as you work through the year this year, your high water mark was the first quarter, trended down through the year.

Is there anything structural about the business that that would be the case or is it just a lot of confluence of a lot of those one-off environmental oriented, maybe not one-off, but environment-oriented costs that eeks through through the year that cause that trend line?

I would say that one the cost pressures, our pricing happened in the first quarter. Our cost pressures got a little bit more extreme as the quarters went by, and then the exchange moved against us, is really the cause in that quarter-over-quarter sequential decline.

That makes sense. I appreciate it.

Thank you. And our next question comes from the line of Liam Burke with Janney Capital Markets. Please state your question.

Thank you. Pat, you talked earlier about consistent concern about the construction market in the US, and how if housing starts got back to the 1.5 million you would be having impressive operating margins.

North American Contractor was up 18% in the fourth quarter. Are those end markets doing any better or worse than you had anticipated from the beginning of the year?

I have quit trying to guess what the markets are going to do, because I was wrong for so many years, but I would say that a Pro Paint business, in the first quarter of 2011, we really started to see some improvement in the kind of underling base business, and the mix on some of the units that are used in larger construction projects like our large gas sprayers and our large electric sprayers. It had really been three or four years when those product lines hadn't done hardly anything, and so in the first quarter we saw that underlying base business get better. And that really stuck throughout the year.

So the optimistic part of me wants to say, well look, we saw a nice trend improvement in our Pro Paint business particularly in what I would call standard bread and butter units throughout 2011, and potentially that bodes well for 2012. Of course the negative part of me says is I was wrong for so many years about when the recovery was going to happen I should just shut up.

I am not really sure, but I would say currently I feel pretty decent about what we saw in 2011, and I am fairly optimistic that we're going to see some sort of a continued slight improvements in construction markets quarter-over-quarter going forward.

And I know you talked about it in one of the earlier questions, but your CapEx gaps from about $24 million to $30 million. Are there any one-off large projects in that, or is it just capacity increases?

It is really a combination of capacity and productivity and new products.

Alright, thank you.

Thank you. And our next question comes from the line of Matt Summerville with KeyBanc. Please state your question.

I just had a couple of follow-ups. Maybe if you guys can comment with or without the ITW businesses, how you're thinking about share buy back here as you start off 2012?

Well, our long-term goal is to have no net increase in our shares outstanding, so our cash flow as you can see are solid. We generated $160 million. Last year our cash balances are greater than our outstanding debt, so we feel good about the position we are in, and we will continue to make opportunistic share buy backs.

Jim, how much of that cash is in the US versus outside?

It is all in the US.

And then just one follow-up on the Contractor business. Are you guys able to give out sort of a break down in terms of how much of your business now is being derived from the Pro Paint channel versus the Home Center channel without getting into individual customers?

We would prefer not to.

Alright, that is all I had. Thanks.

Thank you. (Operator Instructions). And our next question comes from the line of Charlie Brady with BMO Capital Markets. Please state your question.

Hey, guys, just a follow-up. I don't mean to beat a dead horse on the revenue growth rate. But you are giving some broad guidance as to what you expect the growth rate to be for the full year, and on the first quarter across the three business segments, not so much. And particularly given your visibility that you have in the business, I am trying to square that up with the enthusiastic growth rates for, if we're talking double-digit Industrial and Lube for the year, to just get a sense of what that means in Q1 and what the ramp might be through the year? Because second quarter is a tough comp as well.

Just to clarify, Charlie, that I'll also call it the flattish call is really just Contractor in Europe, Contractor globally and then Europe in the, I'll call it the low-single digits. We are looking at in Q1 as well to have double-digit growth in Asia, Latin America, North American markets outside of Contractor. So it's really the contractor market in total that has a tough comp in the North America in Q1. That comp will get easier in the next quarters.

And then we are seeing sort of a bottoming impact in Europe. So again we're looking further on in the year to having some rebound in the contractor market there as well as continuing strength in the Industrial and Lubrication.

Thanks.

Thank you. I'm showing no further audio questions at this time.

Alright, thank you, everyone, for attending the call this morning, and have a good day.

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