Good morning. Welcome to the First Quarter 2016 Conference Call for Graco Inc. If you wish to access the replay for this call, you may do so by dialing 1888-203-1112 within the United States or Canada. The dial-in number for international callers is 719-457-0820. The conference ID number is 4595390. The replay will be available through April 25, 2016. 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 the company’s 2015 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. I will now turn the conference over to Caroline Chambers, Vice President, Corporate Controller and Information Systems. Please go ahead.

Good morning, everyone. I am here this morning with Pat McHale and Christian Rothe. Our conference call slides are on our website and it provides additional information on our quarter. Last evening, Graco reported first quarter sales of $305 million, net earnings of $40 million and diluted net earnings of $0.70. Effective foreign currency translation rates continue to be a slight headwind for us and impacted sales by 2%. Incremental sales from acquired operations contributed 2 percentage points of growth, while organic sales at consistent translation rates declined by 1 percentage point. A brief reminder for everyone. Results for first quarter last year in 2015 included $30 million or $0.49 per diluted share of net investment income from the held separate Liquid Finishing businesses. These businesses were sold in April of 2015. The reconciliation of our operating earnings is included on Page 8 of our slide deck. Gross profit margins this quarter were consistent with rates in the prior year. Favorable effective realized pricing and reduced acquisition-related purchase accounting were offset by timing of factory project spending and volume. Operating expenses increased by $4 million as compared to the prior year, of which expenses from acquired operations totaled $3 million. We continue to invest in new product development and commercial resources. Incremental spending for these initiatives was approximately $1 million in the quarter and offset by slightly lower spending in other areas. Unallocated corporate expense increased by $1 million primarily due to increases in stock compensation and pension. For the full year, we expect unallocated corporate expense to be similar to the full year in 2015. The effective tax rate for the quarter was 31%, up from 22% last year. Post-tax dividend income from the whole separate businesses reduced the effective tax rate in the first quarter of 2015. The effective tax rate of 2016 benefited from foreign earnings tax at lower rates than the U.S. rate and from the federal R&D tax credit that had not been reinstated in the first quarter last year. As you look forward to the next quarter, I would also like to call out a couple of items from the second quarter last year in 2015. First, we completed the sale of the held separate Liquid Finishing businesses in April last year. The conclusion of that transaction resulted in post-tax dividend income and net gain on sale after-tax of $110 million or $1.85 per diluted share. Also during the second quarter last year, we had two non-recurring items that benefited the tax rate related to the completion of a tax planning project and the initial assertion that the company will indefinitely reinvest earnings of foreign subsidiaries to support the expansion of our international business. Combined, we had a favorable tax expense impact of $9 million or $0.15 per diluted share in the second quarter last year. I will turn the call over to Pat now for further discussion.

Thanks, Carol and good morning, everyone. Overall, we are off to a bit of a slow start in Q1. Our revenue from EMEA and Asia-Pacific was solid, while Contractor Americas came in below expectations. Despite the slow start, we are holding to our outlook for the full year. Let me get right into the details by segment and region. Let’s start out with our Industrial segment. On an organic constant currency basis, the industrial business posted low single-digit growth worldwide with double-digit growth in EMEA and Asia-Pacific and a decline of mid single-digits in the Americas. The Americas had a strong Q4 of 2015 growing high single-digits and most of the change from quarter-to-quarter was related to project activity. Generally, we are seeing stability in our major industrial markets in the Americas and do expect the year to be okay. You may recall that in the first quarter of last year, operating margins in the Industrial segment declined by 2 points, 1 point from foreign currency and another from expense leverage. At that time, we discussed on the call that we had an unfavorable regional sales mix. Growth in the Americas had a decline in the international markets. As you can see in Q1 of this year, we had the opposite happened and we have regained the point that we lost a year ago on expense leverage due to regional mix. Incremental margins for this segment were solid in Q1. Moving on to the Process segment, sales were off worldwide on an organic constant currency basis of low double-digits. We had declines of high single-digit to low double-digits in most product categories in this segment in Q1. Our oil and natural gas businesses were particularly hard hit, off by about a third from the first quarter of 2015. The Process…

Thank you, sir. The question-and-answer session will begin at this time. [Operator Instructions] And our first question comes from Matt Summerville with Alembic Global Advisors.

Good morning. Two questions, first what needs to happen and I understand the math behind it, but what needs to happen in Process for you to achieve the growth objective in terms of low single-digits, in particular in oil and gas and mining and then if we would talk about it in that chunk what has to happen in vehicle services and what are you seeing there now?

Yes. We are not going to break out and talk about vehicle services independently. But overall, our outlook for getting growth in Process is not dependent upon some expectation of significant end market improvements in the second half. It’s really a look at internal initiatives that we have got going on. We have made a lot of investments in the Process space really over the course of the last couple of years. We have launched some new products in 2015. We added some sales headcount. We are pushing forward with initiatives. And we believe by looking at what we are doing, that we can still make up ground in the second half. So it’s not betting on future markets that we can’t control, but really trying to look at things that we are doing.

Got it. And then just a follow-up on the contractor business, can you just provide a little more granularity in terms of what drove the lack of leaner performance, if you will, between January, February, March, were your customers taking down inventories, if so, was that kind of a normal thing and I guess how much slippage was there in the impact involved with timing of promotions?

Yes. The end markets in North America are fine. They are actually very strong. And outdoor sales in our channels were good. Our issues in the first quarter, we had some slippage in new product. We had a big new product Q1 last year and some of that has now slipped into Q2 this year. So we will have a – we should have a big Q2 in terms of new product. And then there was a promotional activity that we had thought was going to happen in Q1. They got pushed out. So it was a little bit of a surprise, but I am not concerned that we have lost market share, that we necessarily lost any business. So I may anticipate that we will have a strong Q2 and at the end of July we will be having a different conversation.

Great. Thanks a lot Pat.

We will move now to Joe Ritchie at Goldman Sachs.

Thanks. Good morning guys.

Good morning.

And I apologize I think I may have missed that last question. But just and so I apologize if I am asking the same one, but I wanted to dig into the monthly trends just a little bit just because the double digit decline that you saw in February order rates that just seem to be at odds with what we were hearing from distributors across the rest of the channel. And so is there any more color that you can give us on what happened in February and then the subsequent pickup in March?

Other than the fact that I had a pale look on my face every Monday morning when I looked at week performance [ph], I really don’t have a lot of input to give you on there. It was an odd situation, because January looked reasonable and was running within expectations. And we started getting bookings reports in February that were pretty ugly. But things turned around in March and I can’t put my finger on it. It was across product lines. It was across regions and there was nothing really specific. I was a little bit worried. I will tell you that and might have been the new cycle, might have just been one of those things where everything comes together at the wrong time. But I think that’s behind us.

Okay. Well, good to hear on that front. I guess maybe focusing on industrial for a second, I think you guys put up some good growth there and margin expansion, any other color you can give us on the end markets, specifically as it relates to auto, aero, general industrial, any commentary there?

Yes. Globally, automotive and the Tier 1s that continues to be good business for us. The construction markets worldwide continue to provide opportunities for us, particularly in North America and Western Europe as related to our industrial business, that service portions of that market window and door and cabinet and things like that. The ag market is pretty dead right now. Obviously, mining and oil and natural gas and everything kind of connect to those upstream or downstream outside just the processing of the fluids is tough. So it’s a bit of a mix bag. But generally, automotive and construction are the best.

Okay, alright. And maybe one last question on free cash flow, fully recognized that typically, this is a seasonally low quarter, but 1Q was lighter than normal, how much of that was building inventory for the product introductions and how should we be thinking about your ability to show in your cash converting cycle as the year progresses?

Joe, it’s Christian. Yes, as far as the inventory build side of it there really wasn’t a ton of that going on other than our normal seasonal build that we do in Q1. Obviously, on free cash flow conversion, there was a CapEx aspect of that. And Q1 was relatively high as far as CapEx goes. We got a number of projects going on. Pat talked about in his comments the contractor had a number of machine tools come online too. So those all really happened in Q1, there was some spending associated with that. So as far as the full year goes, we feel pretty good about our ability to get decent free cash flow conversion like we have had historically. So, no concerns at all.

Okay, great. Thanks, guys.

Our next question comes from Mike Halloran with Robert Baird.

Good morning, everyone. So, just following on that, your own inventory, you just talked about that, but the inventory in the channel, it sounds like you feel like the channel inventory normalized out through March and April with the normalizing order rates. Is that fair?

Well, the channel inventory was really driven by the fact that we had the lack of the new product launch and I will say the load in for the promotional activity that we went ahead last year in Q1 that is being delayed this year. So, I think channel inventory is okay. And I think that part of us having a strong second quarter will be that promotional activity and new product load that we didn’t see in Q1.

And then the Contractor EMEA strength was there new product launch that happened there. I know the comps were a little bit easier, but what drove the 20% plus growth in that segment?

Yes, they had some. In general, the environment has been tough over the there in recent years and it seems like construction markets, particularly in the West, are starting to heal, although Central East Europe has been strong as well. So, it wasn’t any one big thing, but the general environment seems to be pretty positive for us.

And then last one, it doesn’t sound like there has been a change, but I want to ask anyways. The sell-through rates you are seeing on the Contractor Americas side for your top customers, has there been any tenor change from them about the market outlook, the positioning of the contractor type products within their portfolios and things? It doesn’t sound like it, but just want to hear what the channel partners are saying right now?

Yes. I know I think everything looks good. I would say it’s a positive environment and channel partners are doing well. Equipment is selling and there is no – nothing that’s really new from any prior years.

Thanks a lot for the time.

Our next question comes from Kevin Maczka with BB&T Capital Markets.

Thanks. Good morning.

Good morning.

On Slide 8, the mix price product cost item was negative this quarter. I am just wondering if you can touch on that. Usually, price and product costs are – you do a good job on. Are you seeing any pricing pressure anywhere in process or anywhere else?

Yes. Now, pricing pressure is – our pricing has been looking pretty normal this year. So, I don’t anticipate any issues or changes on that front as we go through the year, either a little bit of pressure on some of the oil and gas businesses, but that makes up a really small portion of our overall portfolio. Our issue really on the price cost mix has more been on the manufacturing side and manufacturing volumes and spending associated with capital projects that are being implemented in various locations.

Got it. And Pat, you touched on the industrial end markets, auto construction is still good, but just to be clear, what was weak in Q1 in the Americas?

Well, for sure, that big CapEx investments in Ag and anything related to mining and oil and natural gas have all been soft. Around the world, we have seen some softness in marine in certain locations. So, it’s outside of automotive and construction. It hasn’t been great. I mean, even you saw some aerospace having – under a little bit of pressure in Q1.

And so again embedded in your outlook for industrial for the year, do you think the year shapes up much like Q1 or was there a timing issue there as well like in Contractor, where maybe we start to see some better trends in Q2 in Americas and maybe the double-digits elsewhere is not really a sustainable number?

Yes, that’s the way I look at it. I mean, it’s going to jump around from quarter-to-quarter overall we think industrial was going to be okay for the year and I would anticipate the Americas will have a better year than they did first quarter and that the regions will have not as much strength in the rest of the year as they do the first quarter, but we have had noise in that number before.

Yes. Hey, Kevin, it’s Christian. Just to remind you as kind of Pat said in his script that we had a 9% organic growth in industrial Americas in Q4. So, that is evidence of that moving around from quarter to quarter.

Yes, yes, okay. And just finally from me where are you on the timing of your Contractor capacity decision?

I mean, in terms of step function increase to add more floor space?

Yes.

Yes. We have not made a decision as of yet. The team continues to work on alternatives. I still anticipate maybe sometime this year that they will come forward with a plan. I am not sure that we are going to get much spending done. Christian can weigh in on that.

No, I think that’s absolutely right.

Okay, thank you.

We are going now to Charley Brady with SunTrust Robinson Humphrey.

Hi, thanks. Good morning, guys. Just on Contractor, I just want to go back to the comment about your expectation there. You were saying that internally you guys thought you could get, I guess, high single-digits both in the first half and second half. Is that – did I hear that correctly?

First, for the Americas, we expect to get high single-digits for the first half and full year, yes.

Okay. So, that was not an all-in Contractor segment commentary?

No, that was Contractor Americas.

Okay, thanks for clarifying that. And just on the margin contractor, your expectation there of kind of flattish on a year-over-year basis, is it a function of – because you have got the product rollout in Q2 which generally ought to have – I would say some margin, decremental margin hit to it as you are rolling out the cost of doing that, but is it the fact that the higher absorption – the better absorption of higher sales is offsetting that or is there something else – some better pricing you are putting in on top of that new products that go out?

I think it’s a number of factors. So, it’s not just – I mean, there is some loading cost along with that, but there is also product mix aspect that goes with it, because of the fact that there is a home center. There is a good portion of home center that’s happening with that portion of the business. So, that’s what’s keeping it really again as we called out that we are not going to get much expansion in operating margins in Q2.

And I think we are still going to have some of our manufacturing cost in contractors going into Q2 for getting that new capital investments up and running. So, we might see some of that spill in. And I would expect that we will see some of the profitability both from the load in and that capital equipment to start to help us in the second half.

Okay, great. Thank you.

For our next question, we go to Walter Liptak with Seaport Global.

Hi, thanks. I have got a follow on to the contractor discussion. Just I think you went into this a little bit last quarter too. But just with the timing of the promotions for this year and the new product rollout, are these – are the products in the channel now? And how is the sell-through – I mean, it sounds like we are pretty confident that the contractor is going to get – they are going to hit the market in time this year?

Yes. So, the products are moving into the channel. Certainly, on the home center side, we have got a load schedule that we will implement as we go through the quarter. So, I guess, there will always be some risk that the load schedule did not hold. But generally speaking, the products are now available in the marketplace and we just need to roll that home center launch to the quarter. I think the products are going to be well-received and we are feeling pretty good about where we are at.

Okay. Alright, good. And then kind of in a similar way, you talked about growth initiative costs in the process business. I wonder is this in the hundreds of thousands or millions of dollars of cost to get the products out? So, I thought you had a number of products like the ChemSafe and just like the Electric Double Diaphragm that have already been put out into the market. Are there other products than that that you are talking about hitting the market for a better 2016?

So that larger investments in that space have to do with getting feet on the street. When we launched the oil and gas organic product in the middle last year, we had to ramp up the sales force. So, we still haven’t fully lapped all those costs. We have got some activities happening in various areas of the Process segment with facility consolidations. We are implementing new capital equipment. So, there is a variety of things that we got going on as kind of part of putting together a Process segment. And I think I mentioned last time, long-term, that business should have operating margins in the 20s over the short term. We are getting things together, investing in headcount and I don’t see anything here coming through the next quarters that it’s going to stick out like a giant spike. And I think it’s going to be more of the same.

Okay. But when we look at process operating margins compared to last year, it sounds like we should expect that for the full year they are going to be down a little?

If we achieve our low growth rate in process this year, I think that, that’s very likely.

Okay. Okay, great. Thank you.

Yes.

We go now to Matt McConnell with RBC Capital Markets.

Thank you. Good morning.

Good morning.

So, on the process decline, had there been backlog in oil and gas or did you just see a pretty dramatic change in what’s happening in the end market there, because it had been fairly muted some of the declines through most of last year. So, I am wondering what the big kind of sequential change was in the first quarter?

Hi Matt, it’s Christian. Yes, we did have a step down that happened in Q1 with the oil and gas business. We – in fact, we actually did have backlog grow a little bit in Q1, so book to bill was a little bit better than what it comes across when Pat talked about it in his script. So we are probably down in orders, let’s call it mid-20s. Order shipments were down in the, let’s call it the 30s.

Okay. And then was there backlog supporting the revenue last year in that segment, because you were up organically in Process and it just didn’t seem likely the oil and gas piece was causing this kind of variability last year, I wonder if that was just – could you had backlog or any other factors that made it worse this quarter than what we saw last year?

Early on in the year, that might have been the case. But as the year went on last year, obviously any backlog that was there when we acquire the businesses had really come off, so most of that was gone. And so there was a degradation that happened really as we went through sequentially late last year and into the first quarter.

Okay, alright, great. Thank you.

[Operator Instructions] We move now to Liam Burke with Wunderlich.

Thank you. Pat, you had a down year in – down quarter in North America in contracting and it was explained, but you saw good growth outside the U.S. what’s driving the growth there?

So the European, particularly the Western European market and also Central East Europe, it’s coming off of a pretty long, protracted bottom in construction markets there. And although it’s not a steep rebound like we saw in the U.S. coming into the 2010 kind of timeframe, it does look like construction markets are starting to heal there. And if the contractors have got some jobs lined up, they are much more willing to buy equipment. So the environment for us is definitely better there. We did have some new product in that number, although that didn’t drive that entire new number. Still getting hurt pretty significantly in the East particularly in Russia, which was a strong contractor market for us. So looking forward to the time of that doesn’t throw a negative on top of that. But just generally the environment looks better in EMEA. In Asia Pacific, I am going to tell you that it’s spotty. And we have had a good quarter and we have had a bad quarter. And we do have some initiatives going on there. We had a change in management last year. They were hoping we were going to get some traction. But I think it’s too early to ring the bell on that one yet. I think that still expect some noise in Contractor Asia Pacific is probably prudent.

And then on the new product introduction, obviously contractor is going to have a big quarter, but generally on the – across the segments, you are got – you are pretty much on pace to get all them out during the course of ‘16?

Yes. We don’t have a big rush on particular season for a new product in the other businesses like we do contractor. Obviously, a large chunk of our business is not related to the outdoor market. And so our implant stuff pretty much launches when it’s ready. I like what we launched in the second half of ’15. And I think we have got some nice opportunities to continue to build on that in 2016 product launches, but pretty good too. So I am generally pretty happy with across our business units, what we have got in the pipeline for new products for this year.

Thank you, Pat.

And our next question comes from Jim Foung with Gabelli & Company.

Hi Pat and Christian. I am just wondering you kind of called out your discretionary spending in the press release, I was just wondering how much leeway do you have to move those spending around from quarter-to-quarter or year-to-year?

Yes, to call that off really saying, look we are watching our discretionary spending, but really I was trying to emphasize the fact that we still think that we can have a decent year. We like our growth initiatives and we are not cutting or moving forward. And we are watching discretionary items where they make sense. Should things fall apart, there is lots of things we can do at Graco. And we have done them in the past. We know how to do those things well. But I am not anticipating things to fall apart. I am anticipating things to improve as we go through the year. And so really, right now, we are spending on that basis.

Okay, very good. And then also in your annual report, you talked about the new warehouse in Shanghai and you did comment on Asia Pacific, what else do you need to do in China and Asia Pacific to get the growth that you would like to get in the future?

There is lots of opportunities for us over there. If you take a look at the split of our business, that upside in that region is significant. We continue to build our channel, particularly in certain geographies and within certain product lines. We continue to put feet on the street where it makes sense. We are trying to do a better job across the company, I would say over the last 4 years or 5 years in designing products that are tailored for the different needs that are in that market, the needs are not always the same as North America and Western Europe. So we have got a number of initiatives and we continue to press forward with those on a regular basis.

Okay, great. Thanks so much.

We go now to Jeff Hammond at KeyBanc Capital Markets.

Hey. Good morning guys.

Good morning.

Just a final one back on Process, if you do see weakness kind of persist into the second half, is there anything you can do to kind of manage the decrementals a little bit better?

There is. The question will be whether I decide to do it or not. We have got some nice activities underway that are going to drive cost out over the long-term, machining improvements, facility consolidations, putting headcount in regions where we think that we got holes. And if things get really bad, then I will do what I have to do. But I hate the short change the long-term to make one quarters or two quarters look a little bit better. So we have those discussions internally. We have got regular operating reviews here and we talk about our alternatives. But I will tell you, my focus is to try to grow.

Okay, good. And then just to understand on Asia a little bit better, are you more concerned with the macro over there for calling kind of the end of the choppiness or is it more the stuff that you are doing internally to really get things going?

Yes. I mean we have always got our initiatives. But a great economy is better than a great plan. And we are going to continue to push forward our initiatives. But the economy over there is just – it’s just not getting out of its own way. And particularly China, they really drive the region. And it’s just – it hasn’t been strong across the board. It’s been I would say, generally weak. When I talk to our supplies over there, which is another view that we get, we can talk to distributors and end users, but I would also like to talk to suppliers and generally our suppliers are slow, which leads me to believe that manufacturing numbers in China, you can do exactly what they were, they are probably not very good. So I think we need some help on that front from an economic standpoint. But certainly, there is lots of things that we can do and we continue to push where we can.

Okay, great. Thanks Pat.

We go now to Jim Giannakouros with Oppenheimer.

Hi. Good morning guys. Thanks for taking my question. On the contractor, just a follow-up on – to better understand the margin progression there, I get the mix headwinds in new products our way to the home center, when can we expect that mix to no longer be a headwind whether it will be just from a year-over-year comparison, Christian or just given what you see in your pipeline of new products elsewhere?

There is a couple of things going on. You have got the mix between paint channel and home center. And you have got the mix between the regions and the Americas. And then you also have mix between – within our market segments whether contractors are buying our highest end products, like our gas sprayers, we are doing track homes versus whether the electrics are doing well. So there is a lot of mix issues within that. It’s kind of hard to predict. We have had good strong growth across product categories since 2010. And I would say that within the North America pro paint market for sure, we are selling more big units than we were selling in 2010, ‘11 and ‘12. So that mix is improving. But our home center business has done really well. We have launched a lot of interesting products. And so it’s a little bit of a soup.

That’s all I had. Thank you.

There are no further questions at this time. I will now turn the conference over to Pat McHale.

Alright. Well, not our brightest quarter, but we are working hard and we anticipate better things. And we will look forward to talking to you again at the end of July. Thanks.