Graco Inc. (

GGG

)

Q2 2011 Earnings Call

July 28, 2011 11:00 AM ET

Executives

Caroline Chambers – Chief Accounting Officer, VP and Controller

Patrick McHale – President and CEO

James Graner – CFO, Treasurer and Head, IR

Analysts

Tom Brinkmann – BMO Capital Markets

Kevin Maczka – BB&T Capital Markets

Chris Wiggins – Oppenheimer Securities

Matt Summerville – KeyCorp Investment Banking

Eddie Szeto – Goldman Sachs & Co.

Brian Meyer – Robert W. Baird & Co. Equity Capital Markets

Marc Heilweil – Spectrum Advisory Services, Inc.

Presentation

Operator

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Good morning and welcome to the Second Quarter 2011 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 in the United States or Canada. The dial-in number for the international callers is 303-590-3030. The conference ID is 4454163. The replay will be available through August 2, 2011.

Graco has additional information available and 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 the Item 1A of, and 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 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. Please go ahead.

Caroline Chambers

Good morning everyone. I’m here this morning with Pat McHale, Jim Graner and Christian Rothe. I will provide some comments on the financial highlights of our second quarter and Pat will follow with additional comments. Slides are available to accompany this 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’ll open up the call for your questions.

Sales increased by 22% for the quarter including 4 percentage points from currency translation with strong growth in all segments and regions. Changes in translation rates also increased net earnings by $4 million for this quarter. With the strengthening of the euro and various Asian currencies against the U.S. dollar for the quarter, I’ll provide some additional detail on effective translation by regions and by segment.

By region, sales increased in the quarter by 14% in the Americas; 32% in Europe or 21% at consistent translation rates; and 34% in Asia Pacific or 27% at consistent translation rates. When we look at the segments this quarter, sales increased in the Industrial segment by 29% or 24% at consistent translation rates. Contractor segment sales increased by 9% or 6% at consistent translation rates and the Lubrication segment grew by 38% or 34% at consistent exchange rates.

Gross profit margins were 56.5% for the quarter, up 3 percentage points from the prior year. The favorable effect of higher volume, translation and selling price increases were slightly offset by higher material costs.

Operating expenses increased by $11 million, including $3 million related to transaction costs associated with the pending acquisition of ITW’s finishing businesses and $2 million related to the effect of currency translation. Other increases in operating expense include head count additions in product development in Asia Pacific and Europe as well as higher marketing and promotion costs.

The effective tax rate for the quarter was 32% compared to 35% last year reflecting the Federal R&D credit that was not available in 2010 until the fourth quarter. This rate is lower than our Q1 rate based on current estimates of profitability in our International subsidiaries and the effect of currency translation.

Year-to-date cash flow from operations was $44 million compared to $28 million last year. Our working capital requirements increased in line with our increasing volumes. Accounts receivable have increased $35 million year-to-date with DSOs remaining stable. Inventories have increased by $22 million year-to-date to support service level improvements and new product introductions. Other primary uses of cash include capital expenditures of $10 million and dividends of $25 million year-to-date. The second $150 million of the previously announced $300 million long-term debt has been drawn in July in accordance with our credit agreement.

A few other items to note; we expect to see material cost pressures continue through the year at the same level that we saw during the second quarter. At this point, our factories have also largely met their target service levels and factory production levels are expected to be relatively in line with sales growth going forward.

Expenses associated with the pending acquisition are expected to be $2 million to $3 million in the third quarter. So, timing of expense will be affected by the timing of the review process. We expect that expense in total will be in the range of $15 million for the transaction.

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