Good morning, and welcome to the Second Quarter 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 number is 3676995. The replay will be available through 1:00 p.m. Eastern Time, Monday, July 27, 2020. 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 their 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 2019 annual report on Form 10-K and in the 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, Executive Vice President, Corporate Controller and Information Systems.

I'm here this morning with Pat McHale and Mark Sheahan. Our conference call slides have been posted on our website and provide additional information that may be helpful. Sales totaled $367 million this quarter, a decrease of 14% from the second quarter last year. Acquisitions added 2 percentage points of growth this quarter, while changes in currency translation rates decreased sales by approximately 1 percentage point. Net earnings totaled $29 million for the quarter or $0.17 per diluted share, including $30 million or $0.20 related to the impairment charges associated with selling the Alco business. After adjusting for the impairment and other tax adjustments, net earnings totaled $62 million or $0.37 per diluted share. During the second quarter, we entered into negotiations to divest the U.K. valve business, Alco, which has significant exposure to oil and gas natural gas markets. Alco operations contributed $7 million of sales and $2 million of operating losses year-to-date, which have been included within the Process segment. Based on the negotiations to sell, our investment in Alco was revalued in the second quarter, and we recorded noncash impairment charges of $34 million after tax, including $24 million of previously unrecognized foreign currency translation losses recorded in accumulated other comprehensive income. The $24 million loss reserve for previously unrecognized foreign currency translation is recorded in other current liability at the end of the second quarter and will be cleared through accumulated other comprehensive income in the third quarter, as the divestiture was finalized in early July. Our gross margin rate was 49.8% for the second quarter, approximately 3 percentage points below the second quarter last year, primarily due to the effect of product and channel mix, as sales in the Contractor segment increased, while sales in the Industrial and Process segments declined double digits and also due to lower factory volumes and changes in currency translation rates. Realized pricing was favorable. Without a recovery in sales volumes, unabsorbed factory costs will continue to weigh on gross margin rates in the second half, so strong realized pricing partially offsets the favorable effect. Changes in product and channel mix can affect gross margin rates. Our global procurement team has been working closely with our supply chain to keep our lines running throughout the quarter. Given the growth in certain products in the Contractor segment, particularly products for the home center channel, the supply chain for some components is stretched, and we are monitoring the situation closely. Operating expenses, excluding the effect of the impairment, decreased by $12 million from the second quarter last year, as reductions in volume and earnings based expenses more than offset higher product development costs. The reported income tax rate was 31% for the quarter, 13 percentage points higher than the second quarter last year, primarily due to nondeductible impairment charges. After adjusting for the effect of the impairment and excess tax benefits from stock option exercises and other nonrecurring tax benefits, our tax rate was 19% for the quarter or 1 percentage point lower than last year. Cash flows from operations totaled $143 million year-to-date as compared to $164 million last year as a result of lower revenues. Capital expenditures totaled $33 million year-to-date as we continue to invest in manufacturing capabilities as well as the expansion of several locations. Cash dividends totaled $58 million year-to-date. We also completed an acquisition for $27 million in the second quarter, which will be a part of the Process segment. For the full year 2020, capital expenditures are expected to be approximately $80 million, including approximately $50 million for facility expansion projects. We completed share repurchases of $17 million net of share issuances during the quarter, bringing our total share repurchases net of issuances to $62 million for the year. We may make further opportunistic share repurchases going forward. A few final comments, looking forward to the rest of the year. On Page 11 of our slide deck, we note our 6-week booking average by segment. These are the 6-week average bookings through last week, July 17. Based on current exchange rates and the same volume and mix of products and sales by currency as last year, the effective exchange is currently expected to be negligible on sales and a headwind of approximately 1% on earnings in 2020. Unallocated corporate expenses are expected to be approximately $30 million for the full year 2020 and can vary by quarter. The effective tax rate is expected to be approximately 20% to 21% for the full year, excluding the effect of one-time items and any impact from excess tax benefits related to stock option exercises. I'll turn the call over to Pat now for further comments.

Thank you, Carol, and good morning, everyone. Given the wild environment in the second quarter, I'll focus my commentary on our operational status, our strategic focus, sales trends as we progress through the quarter and make a few observations on end markets. Our major factories and distribution centers remained fully operational during the second quarter. High-risk employees remained at home, and we've dealt with the positive COVID-19 cases that we have experienced at various facilities without disruption. By reducing our use of temporary labor in certain factories and flexing our workforce to areas of greater need, we've largely been able to survive the quarter without resorting to layoffs or pay reductions. We had enough work in all of our major factories to keep our full-time people productive. Overall, I'm very pleased with the resolve our employees have shown and continue to show throughout this pandemic. Consistent with what we told you during the first quarter call, we've continued full speed on our growth initiatives. Any expense reductions in the second quarter were the result of variable expenses, such as rebates and incentives, as well as reduced spending on travel and prudent discretionary expense management. Spending on our initiatives for 2021 and beyond have continued as usual. This may put pressure on our short-term financial results, but will position us to capitalize when market conditions normalize. Consolidated order trends improved sequentially throughout the quarter. However, the improvement has not been consistent between the segments. After a terrible April, our Contractor business rebounded with a very strong June, resulting in low single-digit growth for the quarter. The professional paint channel improved, as paint stores opened up to foot traffic. The Home Center business has been on fire for most of the quarter, resulting in operational challenges to meet the demand spike. The outlook for the Contractor business is positive for the second half of the year. Our Industrial business, on the other hand, experienced marginal improvement after the business tanked in April. Access to customer facilities is slowly improving, and quoting activity has increased in many sectors, yet we have yet to see a significant bounce back in orders. Automotive is weak globally, industrial production is down, oil and gas is weak, and uncertainty continues to weigh on the capital equipment appetite of most end users. The outlook for Industrial remains cloudy, and I'm not overly optimistic about the second half. Our Process business didn't drop as severely in April. Despite being down double digits for the quarter, we've seen some positive end market trends. Within this business, we have stronger end markets such as semiconductor and environmental, and weaker end markets such as our lubrication business, which has performed comparably to our Industrial segment. With a wide range of end market exposures, our outlook for the second half remains uncertain. I'm comfortable that our approach of continuing to invest in our growth strategies, such as new product and new market development, will position us nicely to drive strong results once things normalize. We used a similar approach during the 2008, 2009 crisis, and our investors were subsequently rewarded, and we look to repeat this again. Operator, we're ready for questions.

Our first question comes from Deane Dray with RBC Capital Markets.

Maybe we can start with contractor demand and the uptick there. Can you characterize how much of that was just pent-up demand ratcheting back versus some indication of underlying market demand?

Yes. It's pretty hard to tell. I mean, obviously, there are segments of the market that are doing pretty well, as you've seen if you looked at some of the recent data. If you look at our most current 6-week bookings trend, they continue to look really strong. So there's probably some combination in there, but I don't think there's any way to actually measure it.

Good. And then can you flesh out the issue on the supply chain? And was this all in the home center? Are there component shortages? Or is it just the opening up of all your suppliers and their operational capacity?

No, we've been hanging in there, but it's been tight, and that's really we've been doing a lot of scrambling. So far, we haven't run out of parts, but it's a substantial increase from our normal run rate. We just wanted to flag that we're working hard to try to keep things going.

So just to be clear, that it's stretched, but it's not like you're missing any sales. Is that fair?

Not because of the supply of components. We do have labor challenges as well. So we're working through that. But hopefully, we'll continue to pump units out.

Great. Just last question from me is what of the lessons or observations you've seen in China as they ramp back up? And are we approaching anything that you would consider to be a normalized demand yet?

I would say, no. And I don't think China can normalize with the rest of the world being disrupted. I really believe that there's enough production that's tied to demand globally that you're just not going to see 'normal China' until Europe and the U.S. are both running more normally.

We'll take our next question from Matt Summerville with D.A. Davidson Company.

A couple of questions. First, can you maybe comment, Pat, around the 6-week average bookings. Can you give some geographic color around those numbers a bit perhaps?

Yes, we didn't break that out. But I would say generally, Asia Pacific could continue to be lumpy. That's a project-based business. So I'm not sure we can read a whole lot into what's going on with the Asia Pacific. Hopefully, Europe has bottomed. There have been some positive signs here recently that the European business is healing up as many of the shutdowns are discontinued. Of course, our North America business is heavily weighted by contractors. So the good results in Contractor are making the 6-week bookings number in North America look pretty positive.

And then just on the Industrial side of the business, you mentioned auto, but can you maybe give a little bit more end market color in terms of what may be coming back faster versus that booking average? What may be coming back slower, obviously, auto is probably in the slower category? And then specifically, can you speak to what you're seeing in the Construction piece of a business as it pertains, again, I'm just talking about the Industrial segment here.

Yes. So that's a little bit tricky because the products that we sell go through distribution and then go into a lot of different applications, so we make some kind of big estimates when we take a look at our end market exposures there. I think you would probably do better off just looking at the macro data in terms of automotive and industrial production to get a feel for what's happening in our Industrial business. But overall, it's soft. Customers are not welcoming many visitors into their factories, which creates a challenge for us, especially getting our new products in front of customers and trying to upgrade them with products that they have that are already working. So I think we're just going to have to be a little bit patient here in the second half and let things work out.

And our next question comes from Joe Ritchie with Goldman Sachs.

Maybe going back to the bookings numbers for a second. I know we don't have the perfect information, but it was super helpful to get the 6-week average. If I look at the Industrial business, down 26% in June and the 6-week average being down 17%. I mean, if I just take a simple average for the last 3 weeks in July and just assumed Industrial is down, let's call it, down 8%. Is that the right way to be thinking about the improvement from June into July across each one of the segments?

So if I were you, I would just look at it as a data point. I would try not to get too detailed about what it may or may not mean. It's only a 6-week number, and we've got puts and takes and projects and year-over-year comparables. I think if you look at the trend, April, May, June, and last 6 weeks, it looks favorable, and I think that's probably the most you ought to read into it.

Okay. Fair enough. And maybe just kind of following on there. And again, not trying to read too deeply into it, but is it fair to say that July has gotten better than June?

Yes, that's what the 6-week bookings would show.

Okay. Great. And then you guys gave us some colors around decrementals for the second quarter, and we're able to achieve that. As you're thinking through the second half of the year, I know some of it is going to be demand dependent, but how are you guys thinking about decremental margins in 2H?

I think they should be similar to what we laid out for you guys after the first quarter. They're pretty much lined up that way. So it's really dependent on revenue and where the revenue comes in. If we have declines in revenue, you'll see declines in margins that should mirror what we had originally said.

Great, I understand. I have one last question about the Contractor segment. There have been very strong trends recently. To rephrase my question about what you're observing in this segment, is there any sell-in occurring due to previous supply chain constraints, and are you now in a position to restock inventory in the channel? Do you have any visibility on this, and is it contributing to the growth rate at this moment?

Yes. In terms of our actual revenue number, I don't believe that's part of the equation. The shelves aren't overly full, put it that way.

We'll take our next question from Mike Halloran with Robert W. Baird & Company Inc.

The Contractor aspect involves many factors. There is typically strong market demand, along with the introduction of new products. However, there is also considerable variability in end market demand. Pat, could you share your insights on how you view the end consumer over the next 6 to 18 months, considering the balance between unemployment and the increase in DIY projects? What implications do you foresee for your business beyond just the second half of the year?

Yes, it's an interesting question. It's hard to figure that one out. My own personal observations are, is this 'work-from-home' means work some from home and work some on your home. There's lots of paint sprayers being sold right now. If you looked at our mix across Contractor, our mix across Contractor tends towards the smaller units at the present time rather than the large units that we might sell into say a municipality or something like that. It could go a couple of different ways. It could be that people are buying ahead on a project that they were going to do next summer or this fall. But another very likely scenario is there are a lot of people spraying that weren't going to spray and never sprayed before, which will be fantastic for us because there's a really large market opportunity of people that don't spray and the fact that the demand is good right now. People should be having a great experience with our products. They should be telling their neighbors. Hopefully, the other side of the coin here is that there's a larger pie that we can work from going forward. So we'll have to kind of see. I mean, it's early, and there are so many moving parts right now, and nobody knows, but that's kind of what I'm seeing.

That's helpful. On the Industrial side, the prepared remarks indicated a lack of optimism for the second half of the year. However, the sequential trends over the last six weeks have shown improvement compared to prior periods. I'm curious about the lack of optimism; it doesn't mean you expect conditions to worsen. Do you think we've reached a low point and will just maintain our current levels for a while, or do you have a different perspective?

I don't expect us to test lows that we had in that kind of April, May timeframe. I mean, obviously, we could, nobody knows what's going to happen with the pandemic and how people react. But my view is that, that was a pretty severe reaction. And typically, when you see those, you see some sort of a bounce back. I think the real question going forward is how long is the healing process and what does that look like? But I'm not overly concerned that we're going to go back and test new lows.

Makes sense. And then one last question. The new product introduction, the SaniSpray. One, what do you think the opportunity set there is? And then two, just which division is that in? Is that in the Industrial piece? Or is that in the Contractor piece?

We've got that in more than one division, but the lion's share at the moment is coming out of the Contractor business. That's a new space for us. We can see some data on what the opportunity was back before that was COVID. I would say it was modest, and it wasn't a market that we were really focused on. However, with all the changes in the last three months, obviously, the potential for that segment looks a lot more interesting. The CED division decided to reallocate resources to try to capture some of that business. So I really have no idea at this point what the long-term potential of that is. I think we're going to learn more over the course of the next few months, and I think we'll even learn more when the pandemic starts to subside. Are people going to continue to sanitize? Or as people get comfortable with the fact that it's either here to stay? Or we get a vaccine? Are they going to go back to the old ways? A lot of people are talking about a new normal. There's one scenario that says there's going to be a lot more sanitization and disinfecting opportunities going forward than there has been in the rear. If that's the case, then that would be good for us.

Next question comes from Jeffrey Hammond with KeyBanc Capital Markets Inc.

Just on the contractor bookings, can you remind us what the mix is between DIY and Professional and just kind of spike out how starkly different maybe the booking rates are between those two categories?

Yes, Jeff, this is Mark. We don't break out the differences in booking rates or the product categories between the Home Center business and the Pro part of the business. I think the commentary that we've had was that the Home Center business was actually pretty hot during the quarter. Then Pro business, really, we didn't see that pick up until the June timeframe.

Okay. And then just why now on the Alco business? How do you think about your other oil and gas facing businesses?

So the why now on Alco? Really, we've worked really hard for a long period of time trying to fix that business. We took a big write-off on it back in 2016. It was an ill-timed purchase oil at $125 a barrel. We were just never able to get that thing going. About 1 year, 1.5 years ago, we put a couple of Graco resources over there in kind of a last-ditch effort to turn it around, and we weren't successful. With our outlook on the oil and gas market not being very positive and finally getting tired of losing money, we just decided it was a good time to flush the toilet.

Are the other oil and gas facing businesses much more profitable, and that's a unique asset?

So we really only have 1 significant other oil and gas business. We do have a fair amount of oil and gas business that we do with products that are made in our Industrial divisions. Those tend to be in more stable sectors. While we have ups and downs in there, they're not as directly related to production. The other business that we have that is, I'll say, oil and gas exposed, also, is exposed to a fair number of other industries. That business has performed well since we bought it. It's been performing pretty well through the cycle. It's remained nicely profitable. Although it does take its lumps on the top line when the oil and gas market goes bad, it doesn't generate any kind of losses or poor profitability for us. Overall, I feel like we're positioned okay right now in terms of not having anything that's really large that is problematic.

Our next question comes from Bryan Blair with Oppenheimer & Company.

Circling back on the 6-week bookings data a little bit to level set there, was there anything unusual in the prior year period? I'm thinking specifically on Industrial, but your System business can cause some lumpiness, both positively and negatively?

Nothing comes to mind, Bryan. I think it should be pretty self-explanatory there. There's improvement. But with the big caveat that it's a short time period and there can be some choppiness here and there, but there's nothing significant that I remember during that time period.

Okay. Got it. And then can you offer a quick update on your M&A funnel and maybe the potential for deal flow to accelerate in the back half? We've heard from a few companies that seller expectations have become a little more reasonable. Just curious if that applies to your pipeline?

We haven't seen that yet, Bryan. I hope we do. The pipeline is still there, but the number of businesses expressing a desire to be acquired right now is very small. Most external contacts, including bankers, agree that the market is quite quiet at the moment. If expectations have lowered and the market starts to improve, we are prepared to move forward. For now, though, it remains pretty quiet.

Our next question comes from Walter Liptak with Seaport Global Securities LLC.

I wanted to ask about the Contractor growth. I wonder if there's a way to think about it, new products versus market growth? Specifically, you talked a little bit about the SaniSpray. Was that material enough to move the needle on the growth rate? Because we're hearing that some of your distributors sold out of the product, and wondering how you're going to meet demand in the back half with virus cases going up?

Yes. The majority of the business sold out of Contractor year-over-year is the core product line, and then we have a nice little bump with our good product development projects that we have in CED. I think that probably, if you looked at the numbers, you'd say it looks relatively normal. In terms of specifically the SaniSpray, it did give us incremental sales, but it's not reflective of making up for a bad Pro Paint market or a bad Home Center market. Both those markets, as Mark talked to you about, Home Center has been good all quarter with or without SaniSpray, and Contractor business came back sharply in June, again with or without SaniSpray. We look at the overall end market, and we need to sell our core products. If we get some incremental on the SaniSpray, that will be nice, and we did get a little bit, but that's not carrying the weight for us.

I think we have about 18.5 million shares remaining under that program.

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

All right, everyone. Well, thanks for joining the call. Quite an interesting quarter, an interesting time, as I'm sure you would agree. We're going to keep doing our thing and look forward to talking to you again in a few months.

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