Welcome to the Second Quarter 2017 Conference Call for Graco Inc. If you wish to access the replay for this call, you may do so by dialing 1 888-203-1112 within the United States or Canada. The dial-in number for international callers is 719-457-0820. The conference ID is 8781897. The replay will be available through July 31, 2017. 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 2016 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 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. As a reminder, today's call is being recorded. I will now turn the conference over to Caroline Chambers, Vice President, 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 sales for the quarter totaled $379 million, an increase of 9% from the second quarter last year and net earnings totaled $80 million. Diluted earnings per share were $1.38 which included $0.23 for the second quarter related to the adoption of a new accounting standard in 2017, the change in the accounting for tax benefits on stock compensation. Year-to-date, net earnings include $0.28 related to this accounting change. The excess tax benefit is reported when stock options are exercised and the volume of exercises varies from quarter-to quarter. Many of the options exercised this quarter related to grants from 2008 and 2009 which have a low strike price and are nearing expiration. The new accounting standard does not change, in any way, the amount of cash tax actually paid. It only changes the presentation of this benefit that was previously recorded directly in equity to the income statement. Additional notes on this accounting change are included on Page 6 of our slide deck. Diluted earnings per share also included $0.01 for the quarter from reduced intangible amortization expense resulting from the impairment charge recorded in the fourth quarter of 2016. Year-to-date, the reduction in intangible amortization expense affecting diluted net earnings is $0.02. Foreign currency translation was slightly unfavorable this quarter as compared to last year, reducing sales by $4 million and net earnings by approximately $1.5 million. Our second quarter gross margin rate improved slightly as compared to this quarter last year, with strong factory performance and realized pricing offsetting unfavorable effects, currency translation and product mix. Sequentially, the margin rate this quarter was slightly less than the first quarter…

Thank you, Caroline. Good morning, everyone. All of my comments this morning are on an organic constant-currency basis. It was strong second quarter, with growth in every segment and every region of the world and good performance in both developed and emerging economies. In many ways, the second quarter performance felt like the first quarter, again beating our own expectations with broad-based demand geographically and across product categories. I'll focus my comments on a few of the areas that I think are notable. Contractor Americas sales were up low single digits in the second quarter which was expected and reflects the difficult comp from the prior year when we had a large home center load-in and product launches that had been pushed out from the first quarter. Out-the-door sales were solid in the quarter, for both home center and paint store channels. Our EMEA Contractor business posted another double-digit-growth quarter, their fourth in a row. Looking ahead, their accounts do get very difficult in the second half. The Industrial segment posted its best quarterly growth rate since 2014, with the Asia-Pacific Industrial business posting a ninth consecutive quarter of growth. We're continuing to see good project activity and have upgraded our regional view. In Americas Industrial, we remain somewhat cautious. Distributor and end-user confidence is higher than a year ago, but we haven't seen that result in markedly better selling conditions in most of our end markets. Our oil and natural gas operations were down in the second quarter year-over-year and sequentially. Notably, it's less than 5% of our business. And while we have higher expectations for the second half at current oil prices, the picture is cloudy. You'll note in our conference call slides, we mentioned that we're evaluating certain brick-and-mortar projects for as early as 2018, driven primarily by our continued growth. Moving on to profitability. Incremental margins were outstanding in the second quarter. The higher revenue growth is driving strong efficiencies in our factories and our expenses are levering nicely. We don't expect this level of incremental profitability to be sustainable. But we do expect that over the cycle, we will drive incremental margins in the high 30s to the low 40s. Moving on to our outlook. Incoming order rates were strong every month of the quarter in every region. Orders through the first 3 weeks of July continue to be solid. Mindful of a tough Q4 comp, we'd like to see good top line performance continue through Q3. Based on a solid performance in the first half, we're raising our full year 2017 outlook from mid-single digits to mid- to high single digits. We have a very difficult comp in the fourth quarter, resulting in our expectation for a full year growth rate that is somewhat lower than our first half performance. As always, we continue to press forward with our long term growth initiatives and hope that our outlook for 2017 will prove to be too conservative. Operator, we're ready for questions.

[Operator Instructions]. And our first question today comes from Jeff Hammond of KeyBanc Capital Markets.

So just back on incremental margins, good color there, Pat. So as we look into the second half, do we start to get back into that mid- to high 30s range? Or is there still a period where we can kind of run ahead like we have in the first half?

So it really depends, I think, a lot on volume assumptions. If our volume remains strong, I expect our factory performance to be good. I think we're fine on price cost and I'd expect that with these higher levels of volume that you'll see higher levels of flow-through to profitability. Then the kind of high 30s to low 40s, that would be, I'd say, normal over the cycle.

Okay. And then just on -- just a couple of end markets, I think you cited heavy machinery and ag is still challenged and we're hearing a lot better things out of those markets. So can you just talk, prospectively, how you think those markets shape up?

Yes. Generally, what we're seeing is businesses that have an association with construction have been pretty darn good. But here, particularly in the Americas Industrial, some of the businesses there are not associated with construction -- we hear optimism and we're hearing better things from our distributors and end users. But from our standpoint, we really haven't seen that result in a lot of push through. So maybe it's coming. We hope it is. But from our standpoint, we're really not seeing it outside of construction right now.

We'll go next to Saree Boroditsky of Deutsche Bank.

So Industrial APAC has been strong for the last couple of quarters, but you just upgraded the current outlook. So could you talk about what you're seeing in that market and if there was anything that's changed in the quarter that made you more confident, outside of the strong results?

Yes, I think it's just the breadth of results across the region and across product categories. We've seen some consistency now for a couple of quarters. And that's -- that read there has given us some good feeling about what's going to happen going forward.

Okay, that's helpful. And then just staying on Industrial, another strong quarter of margins. And it looked like it was largely volume-related. But product and channel mix were also highlighted in the slides. So could you provide more color on any mix of products or region that helped with the margins?

Yes. Saree, this is Christian. So I don't necessarily want to get into that level of detail, but yes, we did have some overall good health from the volume side, in particular. And as Pat said, price/cost is favorable as well. So the expense leverage that we got off of that had really good flow through profitability.

And we'll go next to Mike Halloran of Robert W. Baird.

So could you guys just talk a little about sustainability here, Pat? I think it sounds like core trends across your businesses are progressing ahead of expectations. As you get back -- to the back half of the year and just kind of ignoring year-over-year comparisons and just thinking about terms of -- in terms of sequentials, anything out there right now that's derailing the momentum? Any concern points you have across those segments?

Yes. I'd say nothing really stands out. I don't have a crystal ball and can't predict what's going to happen in the future markets. But from what I'm seeing right now today, things look to be in a good position. And the organization is performing very nicely from our sales teams, all the way through to our factories. So given that we stay on the rails, I don't see any reason that things are going to change markedly going forward.

Makes sense. And then the CapEx projects you alluded to, was that specifically for the Process segment? Or was that a broader comment across your businesses?

Yes, that's a broader comment across our businesses. We've got a few locations with strong growth we've been putting out that are becoming squeezed and so we'll probably be looking at doing some things starting next year.

And then, any -- that makes a lot of sense. And then, any changes to your thoughts on what to do with your strong free cash flow at this point?

Yes. We have those debates and we'll figure it out. Right now, we don't have a pile of cash that we have to deal with. Obviously, that's going to change as we get into the second half unless we find some opportunities. But we prefer to be opportunistic at this point and not make a decision right now today and we don't have to.

Our next question comes from Matt Summerville of Alembic Global Advisors.

A couple of questions. Just first on process, can you talk in more granular detail about what end markets are driving the double-digit volume gains you've seen year-to-date? While oil and gas is sort of small as a percent of total Graco, obviously. As a percent of the Process business, it's a bit more consequential. And then, after you discuss end markets, maybe talk about at this kind of volume run rate, net of mix fluctuation, what do you think is the right bandwidth of margin profile for this business?

I'll take the first piece and I'll let Christian take the second piece. Within that Process category, we've got our, what was our old Lube business which has got both vehicle services and industrial lube. We've got some semiconductor exposure in there. We've got our sand carry exposure in there. We've got our railcar standard process business for chemicals and pharmaceuticals. So we've got a variety of end markets in there. And I'd say, generally, business has been pretty good outside of oil and gas. Now on the margin question, I'll let Christian take a stab at that.

Yes, Matt, this is Christian. So with regard to the margin, looking at the volumes that we've had so far this year, it's been pretty good. If those kind of volumes hold in, we've been in the high teens on operating margins. That's the ballpark that we're in. In order to get into the 20s, we're going to need more volume.

And then just one last one, in terms of the Contractor business, Pat, how far through sort of in the cycle do you think we're in terms of a resaturation of product into the end user base? I guess, what we're trying to get a sense of is how much further does this Contractor story have to play out, particularly in the Americas now coming up against, not just to 1 quarter or 2 of comps, but a couple of years of very nice growth there?

Yes. I mean, that's a good question. I don't think anybody has the answer. But I'll remind you that our Contractor business really came out of the downturn back in 2010. That's a long time ago. So I don't think what's happening in the market today is reflective of some pent-up demand going back to 2007, 2008. I think we've seen continued improvement in the housing market coming out of the downturn. We've always been of the mind that we ought to be doing at least $1.5 million on housing starts and we're headed back there. We think that, that's a nice, healthy sort of end market for us to be able to sell our equipment. That division, historically, has done a great job with new products and I think the last couple of years is no different. So I think end market dynamics are good. I -- we expect the end market dynamics to continue to stay solid going forward. How long until the next downturn? Who knows. But right now, we don't see it and we think that, that business is going to continue to perform.

Our next question comes from Charley Brady of SunTrust Robinson Humphrey.

This is actually Patrick Wu, standing in for Charley. Just a couple of questions on end markets. I guess, the first question is on end markets. In Process, you called project activity as spotty. Where are you seeing the positive or negative areas? Is pricing getting better on these project businesses? And then, how much pent-up demand are you guys seeing in mining? There seems to be pretty widespread positive commentary that the market is finally seeing a bottom and picking up off a low base. Just any color on that would be great. That's my first question.

Sure. In terms of project activity, project activity, it's blips here and there and it can move our results quarter-to quarter and that's why we call it spotty. I mean, these are ongoing projects that we get from the same customer at the same time. But generally, the volume of products in the pipeline has been pretty healthy through the last couple of quarters. In terms of mining, specifically, we're seeing improvements in sales into our distribution channel that serves the mining market. We think that, that's positive. And commodity price increases, I think we might have talked about this on the first quarter call. But I view rising commodity environment as good for Graco. I view that ultimately, we're going to do better in markets where we have rising commodity prices because we've got a great manufacturing footprint, we've got a strong gross margin, so we're generally able to minimize the negative impacts of rising commodity prices. But rising commodity prices drive a lot of capital investment in markets, like mining and oil and gas, that give us great opportunities. So all in all, I think that, that's a good story for us at the moment.

Great. That's good color. And then just -- this seems to be a little bit of a step-down in terms of selling, marketing and distribution expenses in the second quarter. Is that something that we should expect moving forward? Or is that something that was sort of a change in the dynamics for just this quarter alone? Any color on that will be great.

Yes, I don't think we haven't really had any change of philosophy. We have invested a lot in our growth initiatives over the last few years and we're continuing to invest in those. We have had good expense management. But also, if you look at the last couple of years, we've had some spending in some areas to do consolidations on acquisitions and other activities that have increased our spending and now we're starting to see some results there. So overall, I feel like, generally speaking, we're fully funding our future growth and at the current level of SG&A, it is adequate. And if we get ideas, we'll fund them. But I view, going into the second half, there shouldn't be a dramatic change.

We'll take our next question from Deane Dray of RBC Capital Markets.

This is Jeff, on for Deane Dray. My first question is you had 2 consecutive quarters of double-digit growth. Is there any way you could parse out what's end market growth and what would be market share gain?

No, that's really impossible for us to do. We have really broad product categories that we sell through distribution channel and then they sell into customers. And so our products can be used in lots of different end markets and applications and there is nobody out there that is able to track and aggregate report market shares on most of our product categories. So I'm sure that what's going on is a combination of good end markets and good new product performance and good performance by our channel. But I can't break it out for you.

Got you. And then, are you seeing pricing pressures from e-commerce and maybe how might Amazon become a disruptor in any of your markets like Contractor?

Yes. No, we're not seeing that at present. I'm not overly concerned about it. We're, as an organization, of course, keeping our eye on everything that's happening out there, in terms of channel and technology. But the strong majority of our products do require a lot of support. They get built into systems or applications. And I just don't feel like -- I think that we can use what's going to happen with technology to our advantage versus have it crush us like we've seen in some other industries.

[Operator Instructions]. We'll take our next question from Walter Liptak of Seaport Global.

I wanted to ask you a question about the price/cost and you may have alluded this to this earlier, but I missed it. But generally, how much would you say is price that you got during the quarter versus volume?

Honestly, our factories were running very strongly this quarter and we saw nice performance out of all of them. I think our realized pricing was in line with what we generally are seeing, maybe a little bit on the lighter end this quarter.

Okay. Did prices go up in -- at the beginning of the year? Or -- with some other companies, we're seeing prices going up in the second quarter because of material cost headwinds. When was your last price increase?

Yes. We generally run our price increases consistently at the beginning of the year and we don't do midyear price increases. Again, I've been here a long time and I don't remember a commodity environment that created an overly dramatic amount of pain for us where we would consider anything like a midyear price increase. If you just do the math and you take a look at our overall gross margin, well, then, 45% is going to be cost of goods sold. And of that, there is going to be labor and overhead in there and then things that we buy contain materials, but they also contain labor. So when you really take a look at the impact to Graco of commodity price inflation, it can be a few million bucks, but we've usually got a few million bucks of cost reductions going on in our factories. And I don't really lose too much sleep over the price/cost thing. I think we're well positioned as an organization to be able to handle that. And again, I really do like a rising commodity price environment. I think it really helps our commercial teams. And in the end, we make more money.

Okay. Yes, that's a great position to be in. A follow-on to the Asia question, I wonder if you can talk about the margins on some of those projects in Process or some of the margins kind of in Asia, generally. I don't think you guys break that out typically. But does Asia tend to be -- where does that tend to fall, in terms of kind of a range or profitability by geographic region?

Yes, we don't break that out. I would just tell you that if you take a look at similar sorts of products and end markets, our margins aren't dramatically different around the world. So we don't have huge disparities, in terms of pricing or margins regardless of where we go.

We'll take our next question from Jim Giannakouros of Oppenheimer and Company.

What areas were the sources of surprise versus your expectations? And I know end market discussion, just given that you sell through distribution is tough. But assuming that you have a line of sight internally, can you speak to the product categories that are knocking it out of the park for you?

Yes. I wouldn't say there was any one thing that was a surprise. I'll say from my standpoint, if you go back to where we were at, at the end of the first quarter, it's hard just based upon the environment to take a view that you're going to go up in all product categories and all geographies. And I would say that's the most pleasant surprise. It's not any one particular product line that is surprising me.

Okay. And I guess implications for the second half. Does your updated guidance imply higher second half sales than you had contemplated just a couple of months ago? Or should we take your guidance adjustments strictly as tied to first half outperformance?

Yes. I think probably maybe more the latter. But we tend to be conservative. We take some flak for that. We just go to work every day and do our job and prepare to see how it comes out in the end.

Fair enough. Last question, if I may. In Contractor, I apologize if you did touch on this. But mix influences to margin so far this year and outlook there, appreciating that the handhelds has been a growth driver for you and that's been a negative mix. But I wonder if as we get further along the cycle, that you're maybe upselling and having more highly engineered proportioners, et cetera, being sold at -- influencing mix there?

Yes. I think that's pretty hard to predict. If you're looking to say, in the coming quarter, coming half, what's going to happen with mix, we're always interested in what orders we got last week. We're pretty much book and ship for a large percentage of our business. And trying to predict what's going to happen with mix is pretty difficult.

[Operator Instructions]. And we'll go next to Liam Burke of FBR Capital Markets.

Pat, you mentioned you're happy with the performance of the new products and they were contributing to the growth for the quarter. How has the pipeline been? And do you expect that to continue through the rest of the year?

Yes. It's pretty regular. We don't have a big centralized engineering group. Each one of our business units has its own product development which means that we've got product development activities and new product launches happening pretty regularly in our business units on a regular basis. So I would say the pipeline looks fine. It has looked, I'd say, pretty consistent the last few years. We did a big ramp-up in spending, you may recall, in '07, '08, '09 where we had an engineering team. So I think all of the business units are pretty well-funded and are doing a pretty decent job.

Okay. And on the competitive front, is it pretty much the same? Or are you seeing anybody crop up, particularly in any particular geographic region?

No. There's regional players that pop up from time to time. But I've been here 27 years and all the big competitors are, for the most part, the same ones we had 27 years ago. They're good, strong competitors and they give us challenges around the world. But usually, the regional players have trouble having the geographic reach and I haven't seen anything significantly new on that front.

And with no further questions, I will now turn the conference back over to Pat McHale.

All right. Well, I thank everyone for their time this morning and we're going to get back to work. We'll talk to you at the end of the third quarter.

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