Welcome to the Third Quarter 2016 Conference Call for Graco Inc. [Operator Instructions]. Graco has additional information available in a PowerPoint slide presentation which is available as part of the webcast later. At the request of the Company, we will open the conference up for questions and answers after 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 provision 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 18 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 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 Carolyn Chambers, VP Corporate Controller and Information Systems.

Good morning, everyone. I'm here this morning with Pat McHale and Christian Rothe. Our conference call slides are on our website and provide additional information on our quarter. Graco reported third quarter sales of $327 million, net earnings of $54 million and diluted earnings per share of $0.95. Incremental sales from acquired operations contributed 1 percentage point of growth while organic sales at consistent translation rates increased by 2 percentage points. Changes in currency translation rates have little effect on sales or operating results in the fourth quarter and at current rates we do not expect currency to have a significant effect on the fourth quarter. The reconciliation of our operating earnings is included on page 8 of our slide deck. Gross profit margins this quarter were slightly higher than the rates in the prior year as favorable effects of realized pricing and channel and product mix offset the impact of lower factory volumes. Operating expenses increased by $2 million as compared to the third quarter last year. Expenses from acquired operations totaled $2 million. Unallocated forward expenses were $3 million lower than last year, mostly from pension and stock compensation. Unallocated corporate expenses vary from quarter to quarter and we expect that, for the full year, unallocated corporate expense will be approximately $1 million higher than last year. The effective tax rate for the quarter was 29%, 2 percentage points lower than the rate for the third quarter last year. The 2016 rate includes the favorable effect of the favorable R&D credit that was not available until the fourth quarter last year and the favorable effect of foreign earnings taxed at lower rates than in the U.S. The tax rate for the fourth quarter is expected to be approximately 31% with the full year expected to be approximately 30%.…

Thank you, Carolyn. Good morning, everyone. My comments this morning are on organic constant currency basis. We again posted topline growth during the quarter consistent with the low single-digit growth we posted in the first half of the year. We grew in all regions. In our industrial segment the capital spending environment in the Americas has been weak. Looking at the macro data and what we have seen from our peers it's tough to see the catalyst for a favorable change in the near term. From an end market perspective this weakness is relatively broad-based. In the EMEA region in Q3 the industrial in the West grew nicely at a mid-single digit pace but was more of an offset by declines in emerging markets. Our industrial business in the developed economies of EMEA has been solid for some time now and I don't believe the softness in Q3 is a trend. In the Asia-Pacific region, the industrial segment posted its sixth consecutive quarter of constant currency organic growth. The growth throughout 2016 has been driven by project activity in China. We continue to characterize the underlying markets as weak and expect project activity to remain spotty in the near term. Operating earnings in our industrial segment were relatively flat on flat sales growth year over year. Holding operating margins flat in a no-growth quarter is difficult and I give credit to our operations team for solid performance on the operating margin line. In our contractor segment, growth for the quarter was similar to what we have experienced year to date, high single digits in the Americas, double-digit growth in EMEA and declines in Asia-Pacific. Overall growth for the segment was in the high single digits for the quarter and year to date. In the Americas, contractor sales for the paint…

[Operator Instructions]. Our first question will come from Joe Ritchie with Goldman Sachs. Please go ahead.

First question, Pat, you did give a lot of good color in the slides and you talked about challenging end markets in industrial, especially in the Americas segment, specifically as it relates to capital equipment. Is there any signs of light, any green shoots that you are seeing that you are at least getting some stabilization there and starting to see an improvement? Or is it just things just remain really, really difficult?

Yes. It's not a disaster, obviously, if you look at the numbers. But I don't really see any catalyst that is going to drive things to get real strong anytime in the near future. Obviously, something will happen and we probably won't know it until it does. But as we look at it right now it's just sort of blah.

It still seems that on a year-over-year basis you are able to get some price costs or maybe it was a function of mix. I know there was a one-point benefit year-over-year in the margin side.

Quarter to quarter it has been challenging on the mix perspective and, of course, the lower volume creates challenges for our factories. But as you saw this quarter, we did get some price. And mix moved our way. Our factors performed well and we got a little margin expansion. Obviously, the factories have a lot easier time consistently giving us positive cost moves when we've got some decent mid-single-digit organic growth. But everybody is working hard and I think we're doing okay.

And what's the expectation going into next year on price cost? Commodity prices rising a little bit. Do you guys think that that's going to remain favorable moving forward on how are you thinking about it internally?

We're not doing an outlook on 2017 yet but we have been pretty consistent over the years. We expect our factories to drive towards zero cost change certainly in the years where we get a little bit of growth. We have been pretty successful doing that. In this end-user environment or in this economic environment I really don't expect that we're going to get a lot of pressure on the commodity side. If we do see a lot of pressure on the commodity side, my guess is that will be a positive sign for capital spending and for the top line. So, overall, going into 2017 I think it's probably going to be more of the same.

And maybe one last question for me -- on the process side, like, you experienced a pretty good, nice sequential growth in the quarter. It seems like a lot of end markets have stabilized. Maybe if you could provide some color their specifically around oil and gas and what drove the improvement, that would be helpful.

If you want to know about oil and gas there's a lot of companies to look at beside Graco. It's a pretty small piece for us and I don't think that I can give you any insights particularly into the oil and gas markets that you can't get better insights from somewhere else. From our standpoint we're doing all the things operationally that we expected to do with that business in terms of investing in something organic and product development, some factory consolidations, adding new equipment to improve quality and cost. And on the top line it remains difficult up there. Certainly we had a little bit better run rate in Q3, there are people that have called the bottom, but that's not us.

[Operator Instructions]. Our next question will come from Matt Summerville with Alembec Global Advisors.

Good morning, couple questions. First on the contractor side of things you mentioned that the paint store business was up strongly. Can you quantify that a little bit and the home center business as being flat. Those two had, I thought, been moving a little bit more similarly in terms of step function and year-over-year growth and it seems like you are seeing a deceleration on the home center side. And then could you correlate that to the new product launches you had in Q2 and how those are doing as well?

Sure. From an out-the-door sales perspective both the channels are doing fine. That was really sales into the channel. And if you remember last year, third quarter, we had a big jump in sales to the home center and we had a flattish kind of a number in the pay channel side. This is probably just a comp issue versus Q3 of last year because when you take a look at out-the-door sales of products, that we have, they are fine. No way you can see from quarter to quarter, certainly when we have a big product launch. But that's not really what was reflected in the third quarter, I think it was more of a comp issue. I am feeling pretty good about the end market.

With respect to Asia Pac, I think you mentioned you have had six straight quarters of year-over-year organic growth there. I know you have provided a little bit of end market color around the slides. But maybe just specific to China where are you seeing the strength there from a capital spending standpoint? Do you feel like there's something sustainable? Because, then, you talk about that but then mentioned that it's still pretty spotty and volatile. So I'm trying to reconcile that.

From a project activity perspective we have had projects in everything from vehicles that are electric driven to some more traditional automotive applications. There's been some wind application project as well. So it's fairly broad-based across a number of industries. Again, that's the reason why as we look at it it's tough for us to feel like there's broad-based growth that is happening in that region. And so we remain cautious about it.

Our next question will come from Charley Brady with SunTrust Robinson Humphrey.

Just on your comment, Pat, about EMEA and the third quarter was a little bit softer but you don't think that's a trend, can you just expand about what gives you the confidence that that's not a trend?

Yes. Our industrial business has been pretty decent this year and West in the third quarter was fine, it was just offset by some weakness in the East. And there's nothing that I'm seeing that would really make me believe that that is some sort of a longer term headwind. I think the West is doing okay and the East might move around a little bit. But I'm feeling generally pretty positive about our industrial opportunity in the EMEA.

And on the change in the North America growth outlook, flat from up a little bit, I'm assuming it's really not related to contracts or probably just the industrial and process segment? Is that fair?

Yes. It's part of -- the year is three quarters done, right? When you have a batting average and three quarters of the way the season and you are way below where you thought you were going to be, you have got to face reality at some point. So when you just take a look at the math, what we would have to do in the fourth quarter to get Americas into the growth rate, it just doesn't really seem believable to me, based upon where we're at today. Contractor has some challenging comps in fourth quarter but the end market is good and we've got a good team up there. So I'm not overly concerned about Q4 for contractor and industrial again headstrong comps from last year. I mentioned that we shipped a bunch of backlog in Q4 of last year that we won't be shipping this year and that had a nice impact on our industrial numbers in Q4 last year. So I think it's just prudent for us to lay out our thoughts on that and we'll see what happens.

Was that $10 million delta on the backlog going to Q4 year on year predominately industrial? Or how was it spread?

Yes, it was predominantly industrial.

Our next question will come from Jeffrey Hammond with KeyBanc.

So, two markets that have been more resilient for you guys and just from a market perspective our auto CapEx and non-RISC instruction. Maybe just talk about what your customers are saying prospectively about those markets as you look into the latter part of this year and next?

Yes. From a construction standpoint, we're still positive about the construction markets here in the U.S. and in Western Europe. Obviously, there's some pressure on some of the Asian markets on the construction market. But we're a long ways from where we were and I think that we have still got some nice market growth is going to happen both in Europe and in the U.S. over the course of the next few years. I'm positive about the environment there, despite maybe a little bit of noise from quarter to quarter and some of the watch outs that you might have heard on the coding side. We're seeing pricing and housing holding a lot of markets and seeing pretty good activity. On the automotive side I'd say a little bit more watchful, certainly when you take a look at U.S. output it's at a high level. And what's going to happen going forward from here I think is more likely to be a flattening and that's going to potentially put a bit of pressure on the CapEx spending. Certainly the news is still pretty good in Europe and in APS Christian said, although the end market is not great in automotive it's still pretty good and there's opportunities that we're chasing. So again, more positive on construction than automotive but I think both of them are probably going to hang in there for a while.

Okay. And just on process, just sequentially it looks like sales were up just a little bit and then you had meaningful margin improvement. I think you mentioned some cost savings in there. But just talk about the sustainability of that better margin run rate in process, if we're bouncing along the bottom here.

This is Christian. So compared to the margin in process we've got there's -- this year we have been in that low teens number all year long, just a little bit better off of better volume growth. But overall we're still in a position where slight variances in volume are going to be pretty impactful on the bottom line. So is it sustainable? It's sustainable in the double digit number for sure. Is it going to get beyond the midteens, though? That's the question for us. I think we need to see better growth on the volume side.

Our next question will come from [indiscernible] with Deutsche Bank.

I was hoping you could talk a little bit about corporate expense. It came in lower than prior periods and guidance implies a slight step up in the fourth quarter. So how should we think about this going forward?

Generally speaking, we had to call out our best estimates as to what that's going to be. And when we're taking a look at the full year at this point we're expecting it to be approximately $1 million higher than it was for the full year last year. It doesn't change from quarter to quarter just based on timing of some things.

And how should we think about the margins and contractor in the fourth quarter, just given your very strong results last year?

This is Pat. I think I did mention that our view over a longer period of time is that we would have flow-through margins in the 30s, but based upon some of the new product development work that we're doing now and some of the marketing programs that we're contracting that flow through profitability you ought to expect on contractor in Q4 is in the 20s.

Our next question will come from Dean Dray with RBC Capital Markets.

Maybe we could start with brief comment you had a moment ago about some of the noise in the coding market. What do you make of that?

It's really hard for me to say, probably better off asking the coatings guys, to be honest with you. From a contractor's perspective here in North America and in Europe, they do have work. And while labor is coming back into the market and a lot of the markets it has not fallen off a lot in defining contractors, so they need to use equipment. It remains pretty robust and as long as they have some backlog and as long as they are looking for labor, that's a pretty good environment for us which could be a little different than the coating side. I don't know. But again, I'd say ask the coatings guys.

And we started off the call with point to favorable pricing as helping gross margin. Where are you getting pricing? Maybe quantify, if you could, what's driving these newer projects, how are you able to get pricing in this environment?

Yes, so let me talk to you about the pricing strategy that we have. We put through a pretty modest price increase but we do it on an annual basis, really predictable. Generally we will let our channel partners know sometime around this time of year what they should expect for price increase in January. Typically, we realize maybe 1.5% or so. And it tends to be broad-based. We make it a little bit more with new products. We don't have an across-the-board price increase. We look by product category and even down to the component level and we try to analyze what's going on in the competitive marketplace and what additional value can we bring to the table, what's happening on the cost side. And we try to make, I'll say, very specific decisions category by category of what we do with price. But we do expect on an annual basis that in aggregate our prices go up. And I will say that has been the case for the 25 years I've been at Graco and I anticipate that they will be the case going forward.

And then just last question for me, some clarity on that expected impairment charge. Was this part of a regular impairment test that your auditors do? So what triggered it? And any sense of the size at this stage? And is it broadly across businesses or is it a particular business?

This is Carolyn, just a couple comments. As is the normal case, we do have a fourth quarter test. In this case, as we were looking through the results for the year and getting started looking at our forecasts out for next year and even a little bit beyond, we did recognize that it was time to take a look at this and actually -- so we started the process in the third quarter which is why we called it out now. We haven't completed that work. It was really based on shortfalls in the business to what we were expecting in the second half of the year and in the third quarter in particular that triggers our thoughts to get moving on this process. It's really in the oil and gas natural or direct to businesses and so it's really confined to that part of our business. We did call out the amount that we're currently carrying on our balance sheet for goodwill and other intangibles associated with that direct oil and natural gas business.

And moving to our next question from Jim Foung with Gabelli & Co. Please go ahead.

Good quarter here. I want to ask you about your strategic initiatives. Could you quantify how much you've spent so far on this than was there a spending run rate that's going to continue into 2017?

So if you look at the slide deck we typically will give you an idea of what's happening with our growth investments vis-a-vis a year ago. And I think what you'll see is that we're not cutting our growth investments. We're not trying to manage for the quarter. A good example is contractor. Contractor came in a little light on flow-through margins in the third quarter. We like the product development projects they're working on for 2018. We feel like we need to keep the pipeline full and keep driving growth. So the projects and programs that we believe in we're continuing to invest in. That message is consistent whether you are talking about what we're trying to do with oil and gas, factory consolidations, warehouse moves, international expansion, investments in South America, Africa. We really believe that we need to drive our own destiny and we got a long term view. So for the most part, while we're trying to manage discretionary expenses and I think you see some evidence of that here in the quarter, we're trying to make sure that we're not cutting things that we're going to wish we had as we need to drive growth and as markets improve going down the road.

Okay. And can you just give us your thoughts about potential stock buyback in ASR that you mention?

Yes. On the ASR, we have done one before; that's not the program that we currently have in place. So that doesn't keep us from doing that sometime in the future, but we do call it out in our slide deck just as one potential option. Our mindset around share repurchases is consistent with where it has been most of this year which is -- in fact all this year which is where being opportunistic comes from. So we're waiting for either large pullbacks or will be considered to be major dislocations in the market and then we jump in. And last year we had a number of those opportunities. We ended up being in a good position to be aggressive from time to time and we brought back a number of shares last year. This year the market has only given us a couple opportunities to jump in, in earnest. And we're patient. So if we finish this year without buying back another share we're not going to feel bad about it. If the market gives us an opportunity to jump in and buy back a number of shares here in Q4, we would be fine with that, too.

Our next question will come from Walter Liptak with Seaport Global.

I wanted to ask about one of your initial comments. I think I heard you say that weak industrial you didn't think was a trend. I wonder if you would just provide a little bit more -- if I heard that right, just a little bit more clarity on what you mean by that.

That was specific to our industrial business in Europe. Our industrial business in Europe has been running along at a pretty decent rate and we had, again, decent performance in our industrial business in EMEA in the West during Q3 that was offset by softness in the East. And my comment was that I don't really expect that that softness that we saw in the East that wiped out our gains in industrial EVA in Q3 is a trend. We're still feeling positive about industrial EMEA.

Okay. The industrial Americas being a little bit soft here just recently, what do you think is going on with the capital spending for those sorts of products and projects?

All the data that I've seen, this CapEx spending is under a good deal of pressure here in industrial in the Americas and I don't think we're immune from that. So we're out doing our thing but the environment is such, obviously, people are challenged with topline growth and when they are challenged in topline growth, they are not investing as much as they normally do. So we're going to have to go out there and scratch the projects out. They are not just flowing into us automatically.

Okay. Any guess with project pipeline or anything of when things may turn?

Yes, I really wish I had good data for you on that and for myself. But recognize that we sell through distribution and therefore having a product pipeline that is got enough granularity and accuracy that I could quote that or even hang my own hat on that, that's a dream that doesn't happen.

Asia-Pacific growth continues there and you called out ease of dispensing. Some of the new products that you have come out with -- is there one big project or is this going through distribution? And maybe some market share?

It's a number of new projects. Again, we tend to pick up project or market share. We try to normalize our project work, the one-off type of activity. That's why, again, we still continue to call out that we're not feeling great about the true market growth that's happening. We love the project activity, we'll take it. But again, a broader improvement in the macroeconomic environment is much better for business.

And we're launching new products in that segment just like we do in all of our businesses not any individual product is driving any particular outsized result.

Okay. And if I can switch to the process segment, the value price that's flat is pretty good, considering the oil and gas that's moderately down. Is this a trend that you are seeing in the non-oil and gas process? Or is there anything positive to talk about? I know you called out a few things like environmental in Western Europe being more stable.

Yes, there are a few pockets of things that are going okay. Generally speaking there, we have had a lot of internal activity in our process businesses this year, working on operating improvements. And I think those are going to pay benefits for us down the road in terms of the overall en markets. I'd say they are still challenging. Oil and natural gas, for sure, is the worst. But there are no large markets that we're exposed to that are great right now.

[Operator Instructions]. We will hear next from John Franzreb with Sidoti & Company.

Last quarter you characterized the Americas industrial on South and Central America as being challenging environments. This morning it's not listed anymore. Has that region stabilized or are you just saying with a broad brush the whole Americas is not weakening as you previously expected?

This is Christian. So the South and Central America market, you are right, we did remove it as a challenging characterization on our slide deck which only means [indiscernible] that we didn't put it as improving more stable, so it was just plain removed from our slide deck. So you can maybe say that things aren't getting worse there. But as far as turning it into a tailwind, we're not there.

And you had strong cash flow in the quarter. It looks like some of it went to repaying debt. Are you going to be more aggressive in repaying debt with excess cash in coming quarters?

It's not necessarily an objective of hours to be more aggressive on repaying debt or deploying it in any particular fashion. The cash flow was strong and that's good and we will take it. And this is typically the time of the year that -- the second half of the year is always a really good cash generation period for us. Q3 was particularly strong this year. But there are no new initiatives specifically around that.

And in light of the impending goodwill impairment in the oil and gas side of the business, maybe you could give us an update on your previous acquisition, the powder business from ITW? How is that performing relative to expectations?

I don't want to get too granular with how our businesses are doing, but in general I would say that acquisitions that we have made post-2013 outside of oil and gas in aggregate -- I'm pretty happy with how they pay performed.

Our next question will come from Liam Burke with Wunderlich Securities.

Pat, there are end markets that are weaker, creating pain for your competitors as well. Do you see any additional acquisition opportunities as -- does pricing get any better for potential acquisition targets? Or has the pipeline gotten bigger?

I would say that pipeline is okay. There are still things that we're interested in and there are also things that we're looking at. Keep in mind that the kind of assets that we're looking for, high-quality, high-margin products that are meaningful to an end customer, typically survive downturns pretty well. And even despite the fact that things have been soft for, what, six quarters now or maybe even longer, we're really not seeing anybody getting in line to give those businesses away. If they are not highly motivated to sell, it's not a great time to sell. And if they are interested in selling, generally still they are getting pretty fair multiples and significant demand for most assets. And Christian can weigh in, if he wants. He's got a direct team that works on that.

Yes, we continue to work through our pipeline. And as Pat said, there are some assets that are trading right now and trading at pretty high multiples. That's not to say that if there's a business where we feel like we have a significant synergy, we wouldn't step in and a larger multiple. But for the most part, some of these deals are getting pretty rich.

We will next hear from Jim Giannakouros with Oppenheimer.

If I can ask for some color on what you are seeing in China or maybe just cut it a little differently, if we were to cut your order book into longer cycle versus shorter cycle, how much of your business would you categorize longer cycle? And can you speak to your order trends there? For example, I suspect the project activity that is driving your solid results in China, you may have better visibility there for the next two, three quarters versus your home sales centers in contractor.

Yes, we've got a couple product lines where we've got what I would consider long cycle sales. But the vast majority of our business is pretty short cycle, not to say that our distributors may not have been working with an end-user for some period of time. But again, since we sell through distribution, our visibility in aggregate is limited and we're pretty interested in what our weekly bookings report is going to tell us. So I would say we're probably a good person to look at what's happening right now. But if you're looking for somebody that's trying to figure out what's happening nine months from now, we have very few businesses that give us that kind of visibility.

Got it, okay, and then just one follow-up. Christian, I think you answered on margins in contractor you were asked about incrementals in the low 20s. Was that a 4Q comment or was that how we should be thinking about intermediate term, given mix and new product launch cost, etc.?

That was a 4Q comment. As we finish up our planning and go into 2017 we can talk more about it for 2017 in late January.

[Operator Instructions]. We will hear next from Jeffrey Matthews with Ram Partners.

Last quarter you talked about corporate confidence of your customers, lack of pressing need to spend money. And my question is, with oil firmly at or above the $50 level, it seems and having gone through that crisis period, maybe with the recovery it seems in some of the emerging markets, like Brazil, is there any sign that you might be seeing a shift in some parts of your business? Or is this general kind of blah industrial sector the way it is? And then, related to that, I'm wondering -- everyone talks about the election as something that's keeping companies holding back. And I just wonder if you actually see that from customers.

So, two comments from me and again probably more personal insights than facts here, but I don't see any -- and I travel a lot. And I don't see any global catalysts at present that I say, aha, I think things are starting to turn. Everywhere I go it looks a little soft. So I'm not seeing it. Obviously, somebody is going to see it before everybody else and they are going to make a lot of money on it and hopefully it will be you. But right now I'm not seeing it. I'm just seeing unit business conditions in most markets around the world. Regarding the election, I haven't heard a single customer talk about not making an investment because of the election. In fact, if I heard somebody at Graco tell me that they were going to make an investment in something but they weren't because they want to see what's going to happen with the election, I'd probably fire them. So that's my view on that.

Seeing no further questions in our phone queue at this time, I will now turn the conference over to Pat McHale.

Thanks, everybody, for attending. Despite the challenging environment, you can be sure that we're not cutting the good things that we're working on. We believe that we can influence our own destiny. We got to spend a little money to do that. Everybody is working hard and we will keep trying to put up good numbers. Thank you very much.

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