Graco Inc. (GGG) Q4 2012 Earnings Report, Transcript and Summary

Good morning, and welcome to the Fourth Quarter and Year End 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 number is 4587286. The replay will be available through February 1, 2013. 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 purposes of the Safe Harbor provisions of the Private Securities Litigation Reform Act. Actual results may differ materially from those indicated as a result of various risk factors, including those identified in Item 1A of/and Exhibit 99 to, the Company's 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 obligations 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'll start by providing some top level discussion on our overall financial results for the fourth quarter, and then we'll turn the call over to Pat. Slides are available to accompany our call and can be accessed on our website. The slides include information about our consolidated financial results for the fourth quarter in our usual format. Sales totaled $254 million for the quarter, including $32 million from Powder Finishing operations. A table showing impact of volume, acquisitions and currency by segment and region is included on page 5 of the slides. Translation rates did not have significant impact on sales growth for the quarter. Contractor segment sales were up 13% in the quarter driven by growth in the Americas. Without the increase in sales in Industrial segment are related to the addition of Powder Finishing, sales in the segment were flat compared to the quarter in the prior year, Lubrication segment sales declined by 3% in the quarter. Also without the increase in sales related to the addition of acquisitions and a consistent exchange rate, sales in the Americas grew by 14%, sales in Europe were flat and sales in Asia Pacific declined by 17%. By region, Powder Finishing sales for the quarter were $6 million in the Americas, $20 million in Europe and $6 million in Asia Pacific. Net earnings totaled $42 million or $0.68 per diluted share for the quarter. We have also included a walk on page 9 of the slide deck, to providing the quarter-over-quarter overview of change in operating earnings. Gross profit margins as a percent of sales were 55% for the quarter, up nearly 0.5 percentage point from the fourth quarter last year. Lower margin rates on acquired…

Thank you, Caroline. Good morning, everyone. This morning, I'll give you some color on the trends we saw in our business in the fourth quarter and our views as we move into 2013. Generally, I was pleased with the performance of the company in the fourth quarter. Of particular note was the excellent performance of all of our factories, driving significant quality and process improvements across product categories. Gross margins on an as reported basis improved from the fourth quarter of 2011 to the fourth quarter of 2012 by about 40 basis points. The difference between those two periods however is the addition of the Powder Finishing business, which actually diluted margins by 1.5 percentage points. In other words, the legacy Graco operations improved gross margins by nearly 2 percentage points year-over-year. My thanks go out to all of our purchasing, manufacturing, distribution and customer service employees for another fine year in 2012. The Americas Contractor business had a strong showing in Q4 after a weaker than expected Q3. The improvement was a combination of good team performance, a recovering construction market, new product and easier comps versus a weak Q4 of 2011. Outside the Contractor business I'd say that the business environment for the legacy Graco operations is relatively unchanged from the third quarter. Europe is stable with growth on the east and headwinds in the west. Asia Pacific remains challenging throughout the region and across product categories. On Graco legacy business we knew we had a difficult comp in the fourth quarter versus 2011. Our hope was to try and built from the run rate of the third quarter of '12 and gain some momentum going into 2013. Unfortunately, shipments were spotty in the fourth quarter and sales were down 4% sequentially. I'll get into details more in…

(Operator Instructions) Your first question comes from Charles Brady from BMO Capital. Please proceed with your question.

Hey, good morning.

Good morning.

I just want, on the Contractor business, I just want to understand a little bit, what would happen in the quarter. So you had a new product launch, which helped a little bit in terms of tail-end and you also had may be a little bit of bounced back from Q3, and I guess, I'm trying to understand, we look into 2013 particularly Q1 of 2013, should we expect that growth rate to tail off, it sounds like you've got a couple of things that helped to get a little bit of bounce of Q4 that may be don't carry through as strongly going into the first half of '13?

Yeah I don't want to start slicing our projections quarter-by-quarter, but our projection is is that the environment is going to be good for us here in the Americas in 2013 and we'd expect the Contractor division over the course of the year to end up with growth and in that lower single digit range.

Excuse me.

Okay and can you just clarify.

Excuse me, sorry.

Yeah.

Jim has interrupted me, I had a brain cramp, it was a low double-digit range.

Okay, that makes a little more sense, then.

Thank you. I just dropped $20.

No, you're still okay. Yeah on the other expense line you went through and I missed part of what you said about the extra $2 million, what was that related to?

So were you talking about the extra $2 million in other income.

Yeah.

Yeah, so what we had there was a non-recurring reimbursement of $2 million that was related to some shared employer retention payments.

So Charlie you can think of it similar to the dividend distribution, we received from the Liquid Finishing. The only difference is that $2 million is pretax and the $4 million is after-tax.

Right, and then that's a non-recurring, it's a one-off type thing this quarter, correct?

Correct.

Okay, thanks.

Thank you. The next question come Liam Burke from Janney Capital Markets. Please proceed with your question.

Yes, thank you. Good morning, Pat, good morning, Jim.

Good morning.

Hello, Liam.

On the Lubrication side I know you had some tough flooding in south-east in the Asia-Pacific area, but you did have year-over-year decline in revenue but a significant step up in operating margin. So it couldn't be just volume improvement, where did you see that improvement, where did you see the profitability improvement?

Liam, just to come back to your comment, the segment decline for the quarter of 3%.

Right.

Okay, but it did grows for the year for 7%, but the improvement in the operating performance in the fourth quarter really comes as a result of improvements in our factory and what we're able to deliver on margin perspectives. Caroline do you want to add anything?

Jim's correct on that, what we saw a nice improvement is coming out of the factory really and it ramped up in the year went by.

And just to talk a little bit more about on the industrial lubrication side, these so obviously the mining in Asia-Pacific was tough, are you seeing on other segments success and market share gains there?

Yeah it's really hard to measure without any industry data on that, we are seeing nice growth in that category over the course of last 3 or 4 years as we've really started to improve our product acquisition and we believe that our growth in that category has been better than what the market is doing, so we can assume some market share gain but its hard really to put a metric on it. Keep in mind that our market share in industrial Lube is probably above 3% overall.

Great, thank you.

Thank you. The next question comes from Jim Foung from Gabelli & Company. Please proceed with your question. Jim Foung - Gabelli & Company: Hi, good quarter.

Hi Jim. Jim Foung - Gabelli & Company: When I look at the contract of the business your peak was about $320 million going back to 2006, and looks like you're early approaching that on a revenue basis? The margins at that time was about 28% and I guess you're doing about 18% now. So I guess question is this, how long would it take you to get back to those peak type of operating margins that you had in your last cycle?

Yeah, I'll make a couple of comments then Jim can jump in may be with some more granularity, but the way to think about the Contractor revenue line today versus where was that in 2006 as the revenue line is made of fairly significant different mix. We are still somewhere in that $70 million to $90 million may be plus short fall in our base business product categories. And we've made a lot of that up with our growth of somebody emerging markets and with the lot of the new products that we've launched over the years. The incremental margins on that product compared to what we had in the base business is still a significant headwind for us. So from my prospective, we're going to look at operating margins in Contractor should continue to improve as the base business improves but then we wouldn't be looking for mid 20s until we have housing starts and the corresponding underline, core product strength in that, million and half housing starts range.

So, Jim while you're right that in total we're getting closer back to the peak. When we look at the business in North America and we strip off the additional products we've launched in the last 3 or 4 years from our total market initiative, we still think we're about $80 million and our legacy business under the peak and as Pat mentioned, lot of that $80 million came from the high-end units, that probably will take us, take a housing environment of more $1.5 million for us to achieve. So, we'll see a slow improvement in the operating margins but at the next, this cycle until the housing starts get well over $1.5 million, I don't think we'll approach the 26% to 28% probably low more in the low 20s, 23% or 24%. Jim Foung - Gabelli & Company: So that would be new talk it look at the how's the market improves?

Correct. Jim Foung - Gabelli & Company: Okay. Okay great. Thank you.

Thank you. The next question comes from Kevin Maczka from BB&T Capital Markets. Please proceed with your question. Kevin Maczka - BB&T Capital Markets: Thanks, good morning.

Good morning. Kevin Maczka - BB&T Capital Markets: Pat first on the gross margin, it doesn't sound like there was anything unusual there that helped you this quarter like mix or anything else, I think you called out pricing volume in factory efficiencies and since there wasn't much in a way of organic volume growth I'm wondering, can you say a little bit more about that May -- including the pricing impact and other specific things that are happening in your factories now to drive that other thing you're ongoing normal continuous improvement?

I'll make the couple of comments about the factories and then I'd let Jim weigh in on the pricing. We continue to invest in capital in our factories and really throughout 2012 both with capital that we justified in 2011 and we put in place in '12 and then we're putting in place, we saw the factories have good cost improvements throughout the year and gained momentum and just good work done by folks on cost reduction, Kaizens, capital equipment installations, drove that trend it wasn't any one product line or any one factory, it was pretty broad based improvement by all the groups.

Yeah, for the quarter one thing that stands out is the fact that our factory delivered a 1 percentage point improvement in the gross margin just from their in book productivity, that compares to a flat kind of number for the year. So another words are cost were flat for the year but actually improved gross margins in the quarter by 1 percentage point. So the pricing impact under quarter was basically the same as this year-to-date and incremental margins improved and here it's coming out of the factory and impairment side. Kevin Maczka - BB&T Capital Markets: Okay and Jim your ramping CapEx in 2013, any specific projects there that we should be aware of?

It's really just volume dependent. You probably also saw that our actual number for 2012 was less than we had told you in the second and third quarters and really that’s the deferral of projects that - the CapEx projects that are volume related and those will happen in 2013. Kevin Maczka - BB&T Capital Markets: Got it, and then just finally from me a general question related to ITW and the FTC. You don’t of course have to sell that yet until you get the final verdict from them or decision from them. But is there anything that inhibits you from just going ahead and doing that, assuming you have a buyer at a suitable price?

Well, we have to file an application what the FTC, and the application will disclose the buyers. FTC does have to rule that the buyer is able to keep the competition in the marketplace. So, if we can take a buyer himself and close on asset without the FTCs approval. Kevin Maczka - BB&T Capital Markets: Okay, so you’re just still limbo of sorts until you get that decision?

Correct. Kevin Maczka - BB&T Capital Markets: Yeah.

We don’t want to get ahead of ourselves. Kevin Maczka - BB&T Capital Markets: Yeah, okay. Thank you.

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

Good morning couple questions. First on the powder portion of the business, you've had that now for just under a year. As you look over the next one year period and maybe then thinking longer term three to five years. How would you characterize your expectation in terms of how fast that business should grow organically and what an acceptable margin trajectory would be for that business? Now that you've been it for year, again do you think 30 plus is in the cards like the remainder, the legacy Graco business as to pertain us to the industrial segment?

On a top line perspective that business has got fair amount of exposure to Europe. So over the short term that could be a bit of challenge for us, but they also do very well in Asia and have seen a good growth there historically. And so our view when we brought that businesses that it would be equivalent to our maybe slightly better than the average growth rate that we see in other coatings businesses on the industrial side. So it should be a neutral to a positive from our overall industrial growth standpoint. You'll also recall that this is already a well performing business and our strategy on these things from a integration standpoint was just to make sure that we protect revenue. And so we’ve been executing along those lines and would expect to see some modest improvements in gross margin both by pricing actions and by cost reductions, as we move forward but not any kind of a dramatic increase. I don’t view this business as having the same upside in terms of operating margins that are legacy industrial business, primarily because they sell a lot of call it sheet metal, plastic type components along with the system, the goose, the recovery systems that you’re just not likely to see this sort of margins that we would see on their based value added engineered product.

Got it. And then can you maybe talk just a little bit more about China and some of the emerging markets outside of Europe, I thought you hit on that in a pretty detailed manner. Has your bidding activity improved at all in China? Are utilization rates in issue that is maybe impacting your aftermarket business there, help me understand more about what you’re seeing in kind of real-time, some companies are starting to be a little more optimistic about China and maybe I am misinterpreting, but I just - I am not seeing that from you guys?

I would say that we’re more optimistic about the second half of the year and I think just our culture here is that we think that’s dangerous to be always excited about the second half of the year. Looking at in the short term, our run rates in Asia in general seem to be starting the year out sort of on the same path that they were at in the second half of 2012. That the factories are being used in China, and we haven’t seen a big drop off in our spare parts business, but it was really general softness across the industries probably also driven by a little bit of pull back on CapEx. GDP was still good in China in 2012, we’d love to have a number like that but the fact it was a little bit less than prior year, I think cause people that utilized investments they had in place and a little bit less focused on putting new capability in place. I think they had heard us on the project side. We’d anticipate there could be another six months or that before we start to see the kind of investments at the level that we need to get to get that kind of double digit Asia growth back.

Then just one more Pat in EMEA as Asia Pac you provide a little bit of kind of real-time end market color. Can you do that just for the industrial business in North America kind of what you show and what you expect as we move through the year?

Well, I mean we had a really strong year, so obviously comps are going to be more difficult, but we show strength across really a lot of different end markets and in fact we just finished up our industrial sales meeting that kicked off the year in the last couple of weeks and I would say the overall tone of the sales people is positive. They continue to see people make investments, even in industries that maybe aren’t going that strong. People are looking for costs reduction opportunities and process improvement and I think we’re feeling generally pretty decent about 2013 for industrial.

Thanks guys.

The next question comes from Jim Krapfel from Morningstar. Please proceed with your question.

Thanks good morning everyone.

Good morning Jim.

Why (inaudible) do you think we are with regards to the margin recovery in the Lubrication segment. Do you think this business will achieve mid 20% margins with the next three to five years as I think you’ve previously articulated?

Yeah, I am not sure exactly what the timeframe is, we’ve seen continuous improvement now over the course of the last few years and their expectation was as they get up over that 20% number for 2012 and they did that with some top line growth I think we'll continue to see modest improvement in that, we are investing to grow that business over the 3% market share in industrial Lube. There is lots of opportunity for us to push that product around the world, and we also need to do some things on the product development front. So, Lube has a decent year and they had point, point and a half to their operating margin in 2013. I will be happy and we don’t have a big push on right now to [jam] them back in the mid 20s. We could do that by doing some significant expense reductions but we like the investments that we’re making in that space and we’re going to be patient.

Okay. That make sense, second question. Certainly economic conditions will make segment results choppy, but would you estimate the annual revenue boost, you receive from converting users to spray equipment in Europe in a specific confluence of Contractor segment?

I mean that’s almost impossible to measure if I tried to drove gas out there, Jim will probably jump across the table and tape my mouth shut. We launch new product every year and we add people in the emerging markets. We have a good distribution channel add program in place, we’re doing specialization and so there is really no way to accurately measure the impact of any particular initiative. But I will tell you we really believe in end user conversion and we do thousands of end user conversion demonstrations every year and we have dedicated people not sales people but we have dedicated end user conversion people in Europe that are going around doing that activity. So we think it’s really important and if you take look at the paint consumption there compared to the amount of equipment that’s sold you can see that the runway is along. So we just continue to try to drive that but an exact measurement is really difficult.

Okay. Thank you so much.

Thank you. The next question comes from Mario Gabelli from Gabelli & Company. Please proceed with your question. Mario Gabelli - Gabelli & Company: Yeah, I’d win a double TV but Jim is on the sell side I didn’t that what he is going to ask, I always know.

Hey Mario. Mario Gabelli - Gabelli & Company: When I look at the amount of say dry powder in your financial statement, or I should say electrostatic powder that you’re going to get back. What it what's on your drawing board in terms of tuck-in deals, you did a fairly significant one with ITW obviously ran into a speed bump, but and you must have a pipeline fill of acquisitions, you not do them well as ITW transaction with the FTC is pending or do you just move ahead at some point?

Well, if we found the right deal we would absolutely move ahead as you know people are paying up pretty substantially for deals and the flow control space right now, we do have a number of folks at Greco they have been working pretty hard. They have build a vision of where we want to go and identifying candidates, but we’re going to be careful we don’t want to overpay as well. Mario Gabelli - Gabelli & Company: You've got, obviously you could put a wrapper around the sales of the electrostatic business and get a fairly - you have a number that you have it financeable and there is no concerns over size anymore. There is a limit, the last one was pretty sizable?

Yeah, I think that has an organization where getting battery, we actually started doing some deals back about 10 years ago and we gradually improved and of course the capability of the organization to execute as well as our capability to identify spaces is getting better. So I think we're comfortable doing things that are bigger but again I think we're going to keep our discipline and we're not going to do something just to do it. We're not going to overpay, we need to find something where we can add value, particularly in our core competencies on the manufacturing and engineering new products front. And if we found something and it was sizable we would figure out how to finance it. Mario Gabelli - Gabelli & Company: Never a problem. Just one minor edit, I don't think it, you're in limbo, I think you're in hell on this one. Take care.

All right.

If there are no further questions, I will now turn the conference over to Pat McHale.

All right. Thank you very much, for your participation this morning and we look forward to talking to you again in a few months.

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