Graco Inc.

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 367-6995. The replay will be available from through 1 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 for 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 Pam McHale and Mark Sheehan. 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 two percentage points of growth this quarter, while changes in currency translation rates decreased sales by approximately one percentage point. Net earnings totaled $29 million for the quarter, or 17 cents per diluted share, including $30 million, or 20 cents, related to the impairment charges associated with selling the Elko business. After adjusting for the impairment and other tax adjustments, net earnings totaled $62 million or 37 cents per diluted share. During the second quarter, we entered into negotiations to divest the UK valve business Elko, which has significant exposure to oil and natural gas markets. Elko 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 non-cash impairment charges of $34 million after tax, including $24 million of previously unrecognized foreign currency translation losses, recorded and accumulated other comprehensive income. The $24 million loss reserved for previously unrecognized foreign currency translations recorded in other current liabilities 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 three 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 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 earning-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 non-deductible impairment charges. After adjusting for the effect of the impairment and excess tax benefits from stock option exercises and other non-recurring tax benefits, our tax rate was 19% for the quarter, or one 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 total 33 million year-to-date as we continue to invest in manufacturing capabilities as well as the expansion of several locations. Cash dividends total 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 six-week booking average by segment. These are the six-week average bookings through last week, July 17th. Based on current exchange rates in 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, Carolyn. 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 remain fully operational during the second quarter. High-risk employees remain 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've 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 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, and 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 courting activity has increased in many sectors. However, we've 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, and 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. We look to repeat this again. Operator, we're ready for questions.