Graco Inc (GGG) 2012 Q1 法說會逐字稿

Good morning and welcome to the first quarter 2012 conference call for Graco Inc. 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 is 4530277. The replay will be available through April 30, 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 Management.

During this call, various remarks may be made by management about their expectations, plans and prospects for the future. These remarks constitute forward-looking statements for the purpose of the safe harbor provisions of the Private Securities Litigation Reform Act. Actual results may differ materially from those indicated as the result of various risk factors, including those identified in Item 1A of and EXHIBIT 99 to the Company's 2011 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 as of the time they are made. The Company undertakes no obligation to update these statements in light of new information or future events.

(Operator Instructions). I will now turn the conference over to Caroline Chambers, Vice President and Controller.

Good morning, everyone. I'm here this morning with Pat McHale, Jim Graner and Christian Rothe. I will first provide comments on our first quarter financial results and then follow with a brief discussion about the acquisition of the ITW finishing businesses.

Slides are available to accompany our call and can be accessed on our website. The slides include information about our consolidated financial results in the first quarter in our usual format. We have also included several additional slides about the acquisition and the new finishing businesses, including some historical financial information for the powder and liquid finishing pieces of the business for the first quarter and last year based on management accounts provided by the seller.

Although we are providing some top-level information about the liquid finishing results in the slides, access to detailed operating information for the liquid finishing businesses is limited as a result of the hold separate agreement with the FTC, and we do not have detailed information on current liquid finishing operations.

Graco sales of $234 million for the quarter were 8% higher than the strong first quarter last year, with growth in all segments and geographic regions. Changes in currency translation rates did not have a significant impact for the quarter.

Net earnings totaled $35 million, or $0.58 per diluted share, for the quarter. Earnings were 5% lower than last year. Higher costs and expenses this quarter, particularly for product development of about $2 million, pension of $1 million, acquisition transaction costs of $4 million, and additional interest of $3 million, more than offset the growth in sales and the strong gross margins.

Gross profit margins as a percent of sales were 56.5% for the quarter, slightly lower than last year. The effective higher material cost was partially offset as we began to see realized price increases and improved factory efficiencies. We expect that both realized pricing and factory efficiencies will continue to improve going forward in 2012.

As noted earlier, product development expense increased by $2 million in the quarter as compared to last year, mainly due to increased headcount and project expenses. About half of the increase is in the industrial segment.

General and administrative costs increased by $5 million from the prior year, including $4 million of acquisition-related costs. We expect transaction and related legal costs of approximately $8 million in the second quarter of this year.

Operating earnings were also affected by an additional $1 million of pension costs as compared to the prior year. For the full year 2012, we expect pension costs to increase by approximately $5 million from the prior year. We also expect to make a voluntary contribution to the US-funded pension plan of approximately $5 million later this year.

Interest costs increased by $3 million compared to last year, with a full $300 million of private placement debt in place for the first quarter of this year. We expect interest expense to be approximately $6 million in the second quarter.

The effective tax rate of 34.5% for the quarter is higher than the rate for the first quarter last year due to the expiration of the federal R&D credit.

Net cash provided by operating activities was $23 million for the first quarter, as compared to $14 million for the first quarter last year. Although inventories increased by $5 million and accounts receivable increased by $21 million from year-end due to higher sales, asset performance metrics improved. Capital expenditures were $8 million for the quarter, and we paid dividends of $13 million.

As noted in earlier communications, we entered into an agreement with the FTC at the end of March, under which we were able to close a $650 million cash acquisition of the ITW finishing businesses. Under this arrangement, we are able to manage and consolidate the powder finishing business, but the liquid finishing businesses must be held separate. The independent structure will remain in place until the FTC issues a final decision and order that identifies the products, businesses and/or assets that are required to be divested and the divestiture is completed.

A $450 million revolver was put in place in 2011 to finance the transaction. The credit agreement was amended to allow extension of the revolver until March 2017 and to eliminate the requirement for additional permanent debt beyond the $300 million private placement debt that was put in place during 2011. Available cash balances and borrowing of $350 million under the revolver were used to complete the purchase of the finishing businesses.

During the hold-separate period, while the FTC completes their review, Graco does not have a controlling interest in the liquid finishing businesses. Consequently, the Company's investment in those businesses will be recorded at cost, and the financial results will not be consolidated. Income will be recognized based on dividends received from current earnings.

Slide 11 of our webcast slide deck provides some high-level revenue operating margin and EBITDA information with an unaudited split between powder and liquid finishing operations. Note that these figures are from management accounts and as they are unaudited, we have used rounded figures but want to provide a better sense of the operations and cash flow for each of the pieces.

We did make a change to this slide overnight. The current slide notes overall EBITDA of $80 million, which is before management fees.

With that, I'll turn the call over to Pat McHale.

Thank you, Caroline. Good morning, everyone. These are our first public comments since we closed the purchase of the finishing brands from ITW. So before getting into our details for the quarter, I want to take a moment to talk about the acquisition and the scenarios that could unfold over the next few months.

First, I'd like to welcome the employees and distributors of the ITW finishing brands to the Graco family. We're thrilled to have all of you on our team, and everyone in our organization looks forward to working with you and making all of our businesses stronger.

To remind everyone, we were allowed to close and to begin operating the Gema Powder Finishing business immediately after closing on April 2nd. This is a very positive development for Graco, as this business is a great strategic fit. I'll spend a few minutes talking about the Gema Powder Finishing business.

Graco has not had a presence in the powder finishing market historically. We view this as an outstanding addition of product capabilities to Graco's existing liquid finishing lineup, and is strategically important from a materials development point of view.

The Gema brand is the leader in the powder finishing market, and Gema's powder finishing technologies have proven quality and performance. This business has a strong base of customers, distributors and installations upon which we can build.

Powder finishing is a common and growing application in emerging markets, and Gema is capitalizing on this growth. The end user profile for many powder applications is different than for the traditional Graco liquid business and will give us some diversification. For these reasons and more, we're excited to have the acquired Gema in this transaction.

The other two-thirds of our acquisition from ITW consisted of four brands focused on the liquid finishing market. As we disclosed on several occasions during the past year, the liquid finishing businesses were and are the subject of the FTC's antitrust review.

During the first quarter, Graco made a settlement offer to the FTC that we believe satisfies each of the concerns that they detailed in their complaint, which was filed in late 2011. The terms of the settlement offer remain confidential while the FTC considers it, but I will tell you that it's a material subset of the acquired liquid finishing businesses.

Since the order from the FTC to hold the liquid finishing businesses separate came down in late Q1, the FTC has been evaluating our proposal and vetting it with the market. We don't have a lot of visibility to the process, unfortunately, so I can't give you much for details. I can tell you, however, that the vetting process includes discussions with end users, distributors and competitors.

The FTC's objective is to ensure that the market remains competitive post-transaction. We strongly believe that our proposed settlement meets this objective. However, the FTC will make the final determination regarding the extent of divestiture required. Once their final decision and order comes down, we will have 180 days to divest the required operations. Graco expects to be divesting a portion of the acquired businesses. We just don't know to what extent. We'll keep our investors updated as developments warrant.

No one other than the FTC is in a position to know exactly how long this process will take. In the meantime, the cash that builds within the hold-separate businesses is the property of Graco and available to us. We are very confident in the cash flows of liquid finishing, and it will be cash flow accretive during this timeframe.

Moving on to the first quarter. Broadly, the first quarter came in right where we expected. As you know, we have high expectations for 2012 with growth in all segments and regions. We had a very robust first quarter in 2011 on sales, gross margin and operating margin. I'm happy with how Graco performed in Q1 against these difficult comps.

As Caroline highlighted, our gross margins declined slightly from Q1 of 2011, which was the high point for our gross margins last year. However, our gross margins improved sequentially more than 200 basis points from the fourth quarter of 2011, and I believe there's an opportunity for improved gross margins in the coming quarters.

Looking at this year's Q1 results, we had some limited promotional activity related to product life cycle that put some pressure on our gross margin flow through, and price realization is generally a bit lower in Q1 due to timing issues.

Compared to Q1 of last year, we also had the expense headwinds Caroline outlined for you, incremental pension costs of $1 million, acquisition costs of $4 million, and interest expense of $3 million. All told, these items reduced our after-tax net income by about $5 million.

We also spent $2 million more than last year on product development costs. As our long-term investors know, we view these costs as an investment that will yield future revenue and earnings for Graco. We continue to add engineering teams to our industrial segment, as the opportunities to grow our worldwide base in industrial applications are very attractive. I'm happy to make these investments, as it is one of the best yields that we can get.

When we roll it all together, we feel very good about Graco's overall results in Q1. That said, as we dig further into the performance, we had some areas that were stronger than expected while others underperformed. I will underscore each of these areas as I go through the segments and regions.

Beginning with the contractor segment, sales grew at 3% worldwide in the first quarter. We had difficult comps in this segment in the Americas from the first quarter of 2011, where we shipped $5 million in new store sets as we expanded our presence with one of our home center customers. Despite the difficult comp, we grew sales in the Americas by 3%.

I know that many of our investors are interested in the Americas contractor sales, so I want to give a few more data points here. First, sales to our paint channel contractors were up double digits in the quarter. This is a continuation of a trend that we saw last quarter and is consistent with what some of the major players in the construction market have reported publicly.

There's no doubt that the early spring was a help to Q1 sales for Graco. However, some of the statements made publicly by our customers would indicate that the lift in sales has not been isolated to exterior coatings in the northern geographies. That would indicate that there is more to the market uptick than just weather.

Moving on to Europe, contractor first-quarter sales on a constant currency basis were 1% less than the prior year. I mentioned on last quarter's call that I was cautious on the European contractor segment, particularly for the first half of 2012, and against that backdrop, I'm satisfied with the performance in Q1.

Asia-Pacific contractor sales grew at a double-digit pace in Q1. We continue to focus on end-user conversion, and we have a solid lineup of new products in 2012.

Switching now to the industrial segment, the industrial segment posted double-digit growth for Q1 and a new record for Q1 sales for this segment. We did see some variation between geographies, which I will comment on.

The Americas was the strongest growth region in Q1, reflecting ongoing demand from a broad base of domestic end markets, including general industrial, construction and automotive. Industrial demand in the Americas was a bit stronger than I expected, and our outlook is for growth to continue through 2012.

European industrial sales also grew at a double-digit pace, excluding FX, for the first quarter. Frankly, with the macroeconomic environment and construction market as challenging as it is in Europe, this performance was very strong. Our team in Europe remains optimistic about prospects for the remainder of 2012, although I am somewhat cautious due to the general economic environment.

Uncharacteristically, Asia Pacific posted the lowest growth rate of the regions in Q1. Results were variable by country and product line. China in particular was softer than I expected. I still expect double-digit growth for Asia Pacific in 2012, but we'll be closely watching order rates.

We saw some pressure on operating margins in the industrial segment in Q1, where the prior year was quite strong. I believe that we will continue to expand margins as the year progresses.

Next up is the lubrication segment. Lubrication sales grew double digits again in the first quarter, as the segment posted another Q1 sales record. Growth was outstanding both in Asia Pacific at 25% and in the Americas at 14%. Overall, worldwide sales growth was 14% as we continue to see great demand in both vehicle services as well as our industrial lubrication product lines.

Sales declined in our European lube business, but this is from a small base of $2 million in sales, so minor fluctuations in volume and timing can have a significant impact on the percentages. I anticipate better performance from European lube as the year progresses.

Operating margins for the lube segment also expanded in Q1, getting us back into the low 20s. Our target is to maintain this level of operating margin for the full year. Long term, we believe this business can get into the mid-20s as we continue to drive volume and plant-level efficiencies through the operation.

A few comments about Europe. On a constant currency basis, sales in Europe grew by 6% in Q1. Looking at the varying growth rates within the region, Southern Europe remains the most difficult, where sales declined 4%. The countries in Central Europe grew modestly in the quarter, while Northern Europe grew only slightly.

Overall for Western Europe, growth was only slightly positive. In the remainder of our European region, which includes Eastern Europe, Russia, the Middle East and Africa, growth rates were in the teens. Russia led the way, with the Middle East also posting nice growth.

My next commentary is related to Asia Pacific. The contractor and lubrication businesses had nice growth in the quarter, showing a strong return on the investments we've made in resources and emerging markets for these product categories.

As previously mentioned, our industrial business was a bit soft, however, I still believe we will see double-digit growth for the year. Every segment within this region posted record first quarter sales, reflecting that this remains an outstanding story.

And now for some comments on my outlook. As stated at the outset of the year, we're planning for solid growth in 2012. With one quarter under our belts, the story hasn't changed, although the individual contributions to our growth may vary somewhat. Our new product pipeline is healthy, our factories are performing well, and the investments we made in people and resources in Asia and Europe give us more horsepower for 2012.

We still feel comfortable with the overall expectations for 2012 that were discussed on this call a quarter ago. We believe that our lubrication segment will grow double digits in 2012, the industrial segment will grow at a low double-digit pace, and the contractor segment will be in the single digits, all of this from a record-level performance in 2011.

This outlook excludes growth from acquired businesses. Overall, we expect the finishing brands to grow at a mid to high single-digit rate for 2012.

This concludes my remarks. Operator, we're ready to open the call to questions.

Thank you. The question-and-answer session will begin at this time. (Operator Instructions). The first question comes from Charles Brady of BMO Capital Markets. Please go ahead, sir.

Hey, good morning, guys.

Good morning.

Hey, on your comments on industrial and the Asia Pacific outlook, I guess I'm -- what gives you the confidence that business is going to, I guess, have a rebound for the rest of the year out of Asia Pacific? You've got some pretty tough comps over the next two or three quarters.

Yes, we do. We also have a strong new product pipeline. We've done a lot in terms of expanding both our sales coverage and our distribution channel, and we've of course been in close contact with our operating people over there and we're taking a look at how we think the year is going to play out, and we still feel pretty good about it.

Can you give us a sense of, in Q1, what exactly drove some of the softness in Asia-Pacific in industrial?

You know, it was variable. The last couple of years, every product line, every geography has been kind of on a double-digit tear. We saw more variation in the first quarter with some of the countries performing very well and some not so well. In particular, I called out that China was a little bit soft.

So it's not a situation where we're seeing general softness across Asia-Pacific. We just saw some sort of spotty performance in some countries and on some product lines.

Okay. And then on your outlook, your commentary across the three segments you said it doesn't include finishing. I just want to be clear. Does it include the powder business that you do have under control now, or not?

It does not.

Okay.

Charlie, this is Jim Graner. Just to clarify Pat's comments on China, China did grow in the first quarter, and the softness is the fact that it didn't grow double digits.

Okay. That's helpful. Thanks. And just on product development costs, should -- do you expect to kind of ramp that up at the current level for the rest of the year, or was it kind of front-end loaded for new product development?

You know, at this time -- this is Caroline Chambers. I am not seeing that there's necessarily a great amount that's front-end loaded. We did put in place a few more teams, and the project expense can vary from quarter to quarter.

So our projection is in the $45 million to $46 million spend for the year.

Okay, great. Thanks.

The next question comes from Terry Darling of Goldman Sachs. Please go ahead, sir.

Thanks. Good morning, everyone.

Hey, Terry.

Good morning.

Hey. You know, guys, I guess first on the ITW impact, I'm wondering if you can, Jim, maybe lay out for us how the results are going to -- how it's going to look in the second quarter and beyond given the unique structure here, number one.

Number two, Pat, can you speak to timing at all on the FTC? I realize that's a tough question, but I think people are looking at that July 17th court date. I'm wondering if that's still something to keep an eye on.

And then lastly, on the ITW dynamic, is there any kind of minimum longer-term accretion type numbers we can talk about? Can you in any way refresh the comments you made about a year ago now with regards to level of accretion? Those thoughts would be helpful.

Right, Terry. This is Jim. I'll go first on your question on accretion, and I'll talk to 2013 and then I'll come back to the second quarter. So if you project the EBITDA in 2013 between $25 million and $30 million and you take a pro rata share of the financing costs, so $220 million over the $650 million total purchase price, you'd attribute about $8 million in interest expense to that EBITDA stream.

Yes.

And while we don't have final figures, if you estimate that D&A is in the $10 million kind of range, it should be accretive about $0.10, plus or minus. Again, as we get final valuation numbers and final depreciation and amortization numbers, we'll share those with you, which we expect to get in the first part of June.

But with respect to the second quarter, we've called out $8 million in transaction costs. Those are all around fees, so they're accounting fees, attorney fees and banker fees. And if you're estimating we'll have some one-time costs for asset write-ups particularly on inventory, you're going to see a significant headwind on pre-tax charges in the quarter for about -- I'll put in a number of $10 million to $15 million, hopefully closer to the $10 million than the $15 million. But that's all the clarity we can give today because we haven't gotten the final appraisal worth.

All right, so I'll talk a little bit about your question on timing. You know, just to be really clear, there's not going to be any trial date in July. When we were given the July date for a trial in the court system here, that was based upon if we didn't close the transaction and if we continued to fight this thing in court.

We did close the transaction under the agreement that we communicated with the FTC, and this hold-separate agreement is really the end of the road here. The FTC is going to make a decision on liquid finishing in terms of what we need to do, and we're going to follow through and do that, so there's not going to be any court date, there's not going to be any trial.

In terms of the timing, we don't have a lot of clarity to that. I would hope that sometime in the next two to three to four months, we'll get a decision and order from the FTC, but we don't control that timing, and I'm assuming that depends on a variety of factors, including what else they're working on.

Okay, that's helpful. And Jim, I guess back on the detail you provided -- also helpful there -- a couple follow ups. The $10 million of D&A on the powder EBITDA stream, is that just D&A or does that include an assumption on purchase accounting adjustments and so forth? Or was that the subsequent point you were making that you're still trying to finalize that number and we'll hear that, I guess, down the line?

So it assumes that all the purchase accounting adjustments flow through the P&L in 2012. When we use that term, I refer to the inventory and other R&D kinds of write-ups that are generally amortized over a quarter or two. So it should be complete. We should share with you that depreciation in the business we're acquiring was less than $1 million. That's why on the slides that you see, there's no difference between operating earnings and EBITDA. So just to clarify that point.

And again, this is not -- I'm not trying to lay out the incremental improvement, because in the first quarter of this year we had some interest expense. What I'm sharing with you is an allocation of interest expense in total for this business. We also had some one-time costs in the first quarter. So don't view the $0.10 as an incremental number. It's really the profitability of the powder on a standalone basis.

Right, and subject to variances around what you sell the business for and how it performs, and you're not layering in any synergies cost out and so forth there as well, correct?

Correct.

Okay.

Yes, so the whole accounting for whatever we dispose of with respect to the liquid part that's in the held-separate account is outside of this conversation.

Okay. And coming back to how the cash will be -- from the finishing business will be dividended back to, I guess, the Company in the second quarter, is there any way to gauge how that number might look at this point or how it might compare relative to the $10 million to $15 million of the pre-tax charges you called out? Any way to scope that for us?

Well, it's my intent to -- and again, this is subject to approval of the trustee on the hold-separate -- is to dividend a portion of the cash balance increases in those businesses out in the next nine months. We hope to make that at least equal to our increase in interest expense or the interest expense with respect to that $400 million that we have invested there and any incremental costs.

So I'd like the P&L on a net basis to reflect the benefit of the powder business and zero cost for hold-separate on the liquid side. And my estimate is that's around $15 million to $20 million on an annual basis, so you'll see other income with respect to dividends to three-quarters of that, and of course then the gross amount flowing through the interest expense.

Okay, that's helpful. I'll get back in queue then.

The next question comes from Liam Burke of Janney Montgomery Scott. Please go ahead, sir.

Thank you. Pat, now that you've brought in the powder coatings business, obviously the operating margins are below the industrial -- the normal industrial Graco margins. Are there a lot of customized systems within that product line which hold back margins, or is it more like the Graco traditional, more standardized product?

You know, it's probably a little bit of a blend. It's not a lot of what I would call -- at least what we could call at Graco -- pure custom systems that tend to be more configured systems. They've got standard reciprocators, standard guns, standard controllers, and then the customers will typically do a fair amount of mix and matching.

Of course, they do do -- they do get involved on the [boost] side and with some of the powder reclamation equipment, which is, I'm sure -- I don't know, I guess, at this point for sure, but it's likely to be a lower margin business than the core pumping products.

So we've got a little bit to learn on that side of the equation. When I look at our opportunity with the powder business, the first thing we want to do is protect revenue. We don't want to go in and do anything that's going to harm the revenue stream on the business. It's already a pretty darn good business, so we're going to understand that flow. And then we're going to take a look at opportunities that we can leverage that within our Graco channel or our Graco customer base around the world.

And then from a manufacturing perspective, I do believe there are opportunities for us to do some of the work that they buy on the outside. They tend to be more of a design-and-assemble operation. And of course we're heavy in the precision machining, so I think there are going to be some opportunities there, but it's going to take us some time to sort that out.

Sure. Great. Thank you.

The next question comes from Mike Halloran of Robert W. Baird. Please go ahead, sir.

Morning, everyone.

Morning.

So what -- excluding the acquisition costs at this point, what would you guys think is a pretty reasonable corporate expense run rate at this point?

I think we're in the -- find the right page here -- in the $36 million, I believe, off the top of my head, is the underlying run rate. Again, part of that is respect to the increased pension costs this year of $5 million.

Okay. I'm asking because you had about $4 million in that -- call it $4 million of that $9 million corporate expenses this quarter was related to the acquisition, so you kind of net that out at $5 million. I'm just trying to figure out -- based on your comments there, it doesn't sound like that $5 million is the right number to think about the base excluding the corporate expense, then -- I mean, excluding the acquisition-related expense?

Yes, I was talking on the gross basis. What you're referring to is the unallocated --

Yes, the unallocated.

Yes, so that's more in the $3.5 million kind of range.

$3.5 million? Okay, that makes sense. And then just to clarify a comment that Pat made on the industrial margins. You said you expected those to trend up. Were you referring on a year-over-year basis through -- as we work through the year, or were you saying trend up from 1Q levels through the rest of the year?

I was more referring to sequentially.

Okay.

I think there's some opportunity for us to realize a little bit more price going into the next three quarters, and also our factories continue to run well. So assuming that demand stays where we think it's going to stay, I think there's some upside opportunity.

Okay, that's encouraging. I'm assuming, then, you're referring to that on an organic basis, not --

Correct.

Okay, that also makes sense. And then in the press release, you guys referred to some new product pipeline in the back part of the year. Any way you could talk about that either qualitatively or quantitatively, what types of products you guys are putting out in the marketplace and type of impact you think that might be able to have?

Yes, I don't want to talk about product releases for the second half just from a competitive standpoint. But we started ramping up our product development a few years ago and it's really been a nice contributor to our growth in 2010 and 2011. And when I look at 2012, particularly in the contractor, their new product efforts are a little bit more skewed towards the second half of this year than normal. A lot of times we end up with our big launch for contractor in the first quarter of the year, and that's not true this year.

But overall, I feel like our new product development pipeline is going to contribute like it has the last couple years, and I'd rather not get specific on the products.

Makes sense. Appreciate the time.

So, Mike, I need to correct my comment or expand my comment relative to the unallocated corporate expense. The $3.5 million run rate is before the financing costs -- incremental financing costs on our pension expense. With that, for this year it's more like $5 million a quarter.

Okay. That makes sense.

I should comment that we had nice performance in our pension assets for the quarter. They grew in excess of $20 million. Of course, we don't reflect that growth in our P&L until next year, and hopefully we can hold onto that.

And I'm assuming that's why the planned pension contribution jacked down from $10 million to $20 million last quarter to down to that $5 million range for the year?

Exactly, yes.

Okay. Appreciate it.

The next question comes from Kevin Maczka of BB&T Capital Markets. Please go ahead, sir.

Good morning.

Morning.

I guess can I just ask two more questions to clarify things on ITW? The $8 million in costs that you're expecting in Q2, which I think Jim said may be north of $10 million actually, do those continue going forward or is that sort of one-time fees to deal with the transactions that are now gone? And did you say that the liquid piece will impact the P&L positively even though it's not integrated to the tune of about $2 million, which offsets the sequential increase in the interest expense? Did I get that right?

This is Caroline. I'll take the first part of this to begin with. That $8 million really refers to a lot of the outside costs we're going to have as we just try to wrap up -- the legal transfer of these assets, and the accounting fees and valuation fees associated with that, as well as the costs associated with the continuing review work. So that's kind of outside costs there, to some degree consistent with the costs we've had in the earlier quarters.

And then we are seeing that we do have the ability to recognize income for the liquid finishing part to the degree that we can declare dividends from current earnings. So we're having to take a look at that, and that can also affect a little bit the timing as to when we can recognize that income. But obviously it'd be our desire to recognize that to the extent that we do have those financing costs.

So Kevin, it depends on how you look at the interest expense we had last year. So what I'd like to do, again subject to approval, is dividend enough income from these entities out to cover the financing costs on the $400 million and the incremental costs we have and will incur monthly as to the hold-separate.

So if you're looking at it incremental to last year, your $2 million per quarter is good. If you're looking at it just with respect to the transaction in and of itself, it should be a net. So I know it's complicated, but the whole discussion around this is complicated.

No doubt about that.

Again, we expect to distribute probably around one-third of what the operating earnings are, so there will be a cash buildup in these businesses, roughly two-thirds of their net income, which again will come into the equation when we ultimately dispose of it or when we ultimately put it into our consolidated operations.

Okay. And then back to the core business on the commentary around Asia, can you just give some color around the cadence, if you will, to the extent that you're adding more distribution there?

Because I think with the headlines coming out of China and elsewhere, it's understandable to see some slowing in a short-cycle business like yours, but I would think maybe with the pace that you're adding distributors there, you may be able to still far outpace any underlying growth rate that's there. Can you just comment a bit more on that?

I'll talk to you about the distributor adds, and Jim can make any comments if he wants to on the pace question. But from a distributor add standpoint, that's sort of a regular, ongoing activity for us over the course of the last three or four years, so it's not a ramp.

And when we add a distributor, typically we have to do a fair amount of training to bring that person up to speed. So for example, an industrial distributor might do $150,000 in purchases from Graco their first year, and they might do $350,000 the second year and $750,000 the third year. So that's sort of the nature of the beast in terms of developing our distribution channel, and really what will contribute in 2012 as lots of our efforts from 2010 and 2011 and the work that we're doing this year then will help contribute going forward.

So certainly when you think about our growth strategies, we believe we get incremental growth on new products, we believe we get incremental growth by targeting new markets, and we believe we get incremental growth through the establishment of our distribution channel. And then all those things provide us opportunities to perform better than the underlying market.

However, that doesn't make us immune to changes in economic conditions. So we would expect that over the cycle, we outperform the underlying manufacturing growth rates in a place like China, but if it speeds up or slows down, we certainly will move somewhat in tandem with that. I don't know if that answered your question or not.

No, that's very helpful, Pat. Thank you.

The next question comes from Matt Summerville of KeyBanc. Please go ahead, sir.

Just another question, Jim, on the dividend mechanics from the liquid finishing business. Is that $15 million to $20 million that you guys are kind of hoping the trustee okays to formally shift over to Graco, is that $15 million -- how do the tax mechanics work on that $15 million to $20 million? Because coming out of the liquid businesses, that would be an after-tax number, I would imagine. So can you just talk through that briefly?

Yes. Again, it qualifies for the dividend exclusion at the corporate level, so there will be no incremental tax at the Graco level. So again, that's part of the detail that we need to figure out. And just to clarify, this is not a shareholder dividend. This is an inter-Company dividend.

Sure. Sure.

To the extent, of course, they're coming from US entities, they have the exclusion, and to the extent they're coming from foreign entities, they will bring along foreign tax credits. So expectation is there should not be any incremental taxes at the Graco level.

Got it. And then, Pat, can you just comment a little more maybe by geography in terms of what you've seen over the last couple months in terms of order tempo January, February, March, and maybe what you've seen thus far in April. Specifically whether or not you've seen kind of your Asia business incoming order rates bottom out there or whether you feel there's additional deceleration?

So, Matt, I'll handle that question. So with respect to geographies; North America, the trend continues the solid growth there, and we expect that positive to come. On Europe and Asia Pacific; we don't have much visibility. We're three weeks into April. But we are seeing sequentially in March and April a slight improvement in both the weekly order rate from Europe and a slight improvement in the weekly order rate sequentially from Asia.

And then can you maybe also just lastly talk about in the contractor business, how you guys are feeling about channel inventories in both the paint and home center side of things? And then I think you mentioned your paint center business was up double digits. Are you still seeing that net improvement in mix or those ASPs in sell-through improve relative to either sequentially or a year ago?

Sure. We feel pretty good about the inventory levels in the contractor channel, and specifically I'm referring to the US, where we get some of the out-the-door sales data. Our customers are selling the product and it's moving through, so I don't see any big disconnect between what they're buying and what they're selling. And I think that that's generally good news for us. And as the business continues to improve here over the next few years, I would expect that they will increase their stocking levels. But I think their stocking levels are pretty appropriate for where they're at today.

Mix -- and again, I'm going to specifically talk about North America Pro Paint mix. Mix was a little bit interesting in the first quarter. We had seen a nice mix shift starting about a year ago towards moving higher value units in our Pro Paint contractor. And we continued to see that here in Q1 with nice double-digit increases on our larger contractor units. But we also had a really significant increase in Q1 at the low end of our electric line.

And we really believe that that is some share performance that we had here in the first quarter in terms of getting the customer's wallet and getting them to put some of our smaller electrics in stock in preparation for the painting season in lieu of our competitor. So that created a little bit of an interesting situation in contractor that's different from the last year, but my guess is is going forward into the second and third quarter, that that probably straightens itself out. And I think that could give us a little bit of upside potential on gross margins in contractor going forward.

Thanks a lot, guys.

(Operator Instructions). We have a follow-up question from Terry Darling of Goldman Sachs. Please go ahead, sir.

Thanks. Yes, maybe following up on the contractor comments there, Pat. The negative mix that you had in the first quarter, if we were to also strip out the impact of the one-time sale, which I think you indicated was $5 million at the revenue line, and I think you had said in the past it was like $2 million at the profit line, but maybe I could get a refresh there.

Looks like your margins or your profit dollars excluding those were actually down year over year. Is that correct?

No, they -- the profit margin improved. I think on page -- where is it -- 15 and 16 of the slides that accompanied the call, you can see that our operating earnings grew from 16% of sales to 17%. And revenue leverage on the next page in round numbers went up $1 million on a $2 million increase in revenue. On an un-rounded basis, the leverage percentage was over 80%. So the operating margins improved and significantly with respect to the percent of sales, and they grew 13% in dollars on a 3% increase in sales.

So maybe the way to ask the question is just the profit impact related to the $5 million channel fill -- was that not a $2 million headwind last year?

Well, we had some operating expenses related to that, in particular store displays. So I would say that there probably was not significant contribution into the profits last year.

Okay. And then, Pat, in terms of how you're thinking about organic for contractor Americas on a full-year basis, I think if we make that revenue, the channel fill adjustment again, I guess, at $5 million would suggest you were up kind of 10% year over year. And I think I heard you say, though, you're still expecting single digits for the year.

That's a worldwide number.

That's worldwide, okay. Can you maybe help us -- presumably looking for contractor Americas to be double-digit then at this point?

I think there's a chance.

Okay. And then shifting back over to the industrial side and trying to understand the year-over-year decline in percent segment margins there, I know there are a lot of moving pieces in there. But I'm wondering if what we're really seeing there is the effect of the geographic mix, and so the translation is, again, Asia margins above segment average on a more normal basis. Which, again, dovetailing, Pat, into your comment about looking for margin improvement over the back part of the year, that's just tied right in with the view that Asia comes back as well. Or are there other things going on?

I think it's more of an issue of the product development spending increase that we had and a little bit of pension flowing through a couple different lines there. I think it's less related to mix. So our contractor mix is a bigger deal, I think, going from the US to Europe and Asia, where they don't have the home center business. Industrial business is good in Asia, but I don't think that that slight difference in growth rate between the Americas and Asia Pacific is the cause. I think it's more related to the investments that we're making.

Okay. Was there a product mix negative in the quarter as well that might be influencing it too, or no?

Not that I'd call out.

And the re-acceleration in Asia industrial growth, Pat, are you thinking that's more second-half weighted, or do you see enough on the order book or what have you to feel like you're going to see a bounce starting in the second quarter?

Well, it's not clear. It's always easy to say the second half's going to be better, right? That's the standard line that everybody gives and (laughter) not exactly right.

But based upon the comments that Jim gave you -- again, a very short window up through the first few weeks of April here -- it would appear that we may have seen the bottom and that we're seeing some slight improvement off the bottom going into the second quarter here. So I'd like to see that trend continue the next couple of months and backup our thoughts with some good performance.

Okay. And then just, lastly, in terms of how industrial is going to look in the second quarter relative to your comments, I guess we can imply that you've got $30 million or $32 million of powder revenues that come in as acquisition revenues.

And then, Pat, from a margin perspective, I guess your comment that you'd expect sequential improvement there -- presumably that's, though, dampened down by the impact of the acquisitions, which are coming in at a lower rate, including all the purchase accounting items and so forth. Is that -- we got those pieces right there?

That's correct. My comments are related to the base business, the organic growth.

Thanks very much.

We have a follow-up question from Charles Brady of BMO Capital Markets. Please go ahead, sir.

Thanks. With regard to the contractor segment, are there any product fill opportunities in '12 that you're looking at, or is this just kind of purely straight on business -- existing business growth?

Yes, I don't want to get too specific, but we do have a couple of products that are going to launch yet here in 2012 that we're optimistic about.

Would that be second half?

Yes.

Thanks.

Thank you. We have no further questions.

All right. Thank you very much for your time today, gentlemen.

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