Good morning, and welcome to the Fourth Quarter 2018 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 caller is 719-457-0820. The Conference ID is 5631887. The replay will be available through February 2, 2019. Graco has additional information available in a PowerPoint Slide presentation, which is available as a part of the webcast player. At the request of the Company, we will open the conference up for question and answers after the opening remarks from management. During this call, various remarks may be made by management about their expectation, plans, and prospect 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 the Item 1A of the Company's 2017 Annual Report on Form 10-K and in Item 1A of the Company's most recent Quarterly Report on Form 10-Q. These reports are available on the Company's website at www.graco.com and the SEC's website at www.sec.gov. Forward-looking statements reflect management's current views and speak only as of the time they are made. The Company undertakes no obligations to update these statements in light of the new information or future events. Please add any appropriate comments you have as the teleconference provider. I will now turn the conference over to Caroline Chambers, Executive Vice President, Corporate Controller and Information Systems.

Good morning, everyone. 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 you may find helpful. We saw sales growth in all segments and regions in the fourth quarter with an increase of 8% from the prior year, including 2 percentage points of growth from acquisitions. Currency translation was a headwind for the quarter and reduced sales growth by 2 percentage points. Reported net earnings totaled $74 million in the fourth quarter or $0.43 per diluted share. Unfavorable currency translation reduced net earnings by $2 million. Gross margin rates decreased by 2 percentage points this quarter as compared to last year, due to unfavorable currency translation, higher production costs and product mix. Total operating expenses for the quarter increased by $1 million compared to the fourth quarter last year as expenses related to acquired operations of $3 million, and increased volume and earnings growth related expenses were largely offset by the effects of currency translation and lower unallocated corporate expenses. The effective tax rate for the fourth quarter in 2018 was 18% reflecting the net effects of U.S. federal income tax reform. The 2017 fourth quarter rate included the impacts of excess tax benefits related to stock option exercises, the effects of tax reform legislation and other tax planning activities. And the fourth quarter 2017 tax rate excluding these items was 31%. For reference, the reconciliation of non-GAAP adjustments is included on Page 18 of the slide deck. Cash flow from operations totaled $368 million in 2018, compared to $338 million in the prior year. Cash used for equipment additions and facility expansions totaled $54 million, less than projected earlier as timing and cash payments for several projects shifted slightly. During the fourth quarter,…

Thank you, Carol. Good morning, everyone. All of my comments this morning are an organic constant currency basis. Caroline has covered the details on our fourth quarter and full-year earnings adjustments, so any references to profitability will be on an as adjusted basis. Q4 was a good finish to another good year. Thanks to broad-based market demand and the hard work of our employees, distributor partners and suppliers. Some color on the segments. The Industrial segment delivered high-single digit growth for the quarter, finishing 2018 in line with our full-year outlook. Overall demand in this segment remains broad-based, with automotive and electronics remaining stable and general, industrial and alternative energy markets favorable. The Process segment had a great year, delivering four consecutive quarters with double-digit growth. We continue to see good returns from our strategic investments in this segment and favorable demand across most of our end markets. The Contractor segment delivered mid-single-digit sales growth in Q4 led by strong double-digit growth in EMEA. North America eked out a slight gain as double-digit sales growth in the pro-paint channel was offset by softness in the home center channel. Both channels had positive but slowing out-the-door sales in Q4. The second quarter in a row, the Contractor segment operating margins were challenged primarily due to a gross margin decline driven by the impact of tariffs and material cost increases and factory spending. While some of these impacts will be moderating with pricing and other actions in 2019, we expect the impact of the factory expansion to weigh on incremental margins for Contractor in 2019. Timing of expenses and the extent and timing of labor inefficiencies related to the factory expansion are difficult to predict by quarter. But I'd say negative Contractor incremental margins are more likely in the first half of…

Thank you. The question-and-answer session will begin at this time. [Operator Instructions] We will take our first question from Charlie Brady from SunTrust Robinson Humphrey. Please go ahead.

Pat, just wondering, in terms of the commentary about pricing offsetting tariffs and increased raw materials, I see, we talked about that for the full-year or are you there right now as we're into Q1?

No, we'll have to see how Q1 plays out. Our price increase rolls in through Q1. And of course, there are some projects that we reported in Q4 that will hold pricing on through Q1, so I'm not too sure about Q1, but we should be in good shape for the year. And I would expect us to be in real good shape going into the second quarter.

Great. That's helpful. And just on the home center sales being a bit softer. I know recently, they were up, but have you seen that flip around in the first quarter here?

I can't tell you what the run rate has been in the last few weeks.

Got you. Okay, I'll get back in queue. Thanks.

We will take our next question from Deane Dray, RBC Capital Markets. Please go ahead.

Good morning, everyone.

Hey. Good morning, Deane.

Hey, maybe we can start on Contractor and maybe this was an overreaction, but there was an expectation that when there was a negative preannouncement in one of the paint suppliers that you all would have fared worse, you did mention some softness in the home center market, but didn't seem that material. Can you give us some color there, please?

Yes, I know it's hard to line up our numbers with the paint manufacturers on a quarter-to-quarter basis. In general, what we're hearing from the field is the contractors are busy and they've got jobs lined up and they need equipment. So we then going into 2019, even though you may have seen a little bit of softness in the non-res market that the general construction markets are looking pretty good, contractors are going to be busy, and we're expecting to have growth.

Got it. And then just broadly, the impact of tariffs, it still sounds as though you're well positioned on pricing even though you haven't seen the benefit yet. But just can you get any more specific on the impact of tariffs, and what it may have had in terms of ripple effects on the supply chain?

Yes, Deane, it's Mark here. And when we look at 2019 and the pricing actions that we are going to implement, we think that we're going to be able to more than offset the tariff impact based on our calculations and that means that we will realize some pricing over and above the tariffs kind of typical what we've done in the past. Of course, these things, you never know how they will actually play out, but I think that our current estimates are good and we feel confident that we're going to be able to more than offset the tariff impact.

Got it. And just last point or last question. Anything on China in terms of the tone of business? The kind of visibility that you have today, but anything you can share versus how you started the quarter?

So I think we're seeing the headlines that you're seeing. But really on the ground over there, we've got a lot of interesting things that we're working on and we still see good opportunities for 2019. So I would say that we're generally positive on our prospects in China for 2019.

Good to hear. Thank you.

Thank you. Our next question is from Jeffrey Hammond from KeyBanc. Please go ahead.

Hey. Good morning, guys.

Good morning.

Good morning.

Just, Pat, back on the Contractor margins, can you just maybe break out what you think - how much you think is mix versus kind of these tariff headwinds versus the factory disruption? And then along the lines on those three, how you see those shaking out as you move into the first half and second half of 2019?

Yes. So it's a number of pieces here in Q4 and I'm going to let Caroline go ahead and weigh in.

Regarding Contractor and specifically, it's probably more heavily weighted toward both factory spending and tariffs and material cost increases. Having said, overall, we had the product mix affected our overall corporate margins as well, particularly with a lot of finishing systems being build out this quarter as well as acquired operations. Currency also played a role of a nearly half of a percentage point on the corporate basis and the rest was really factory spending, a lot of which was driven by projects and getting ready to bring in new equipment next year.

And so Pat, the comment or the comment on kind of margins still being under some pressure in the first half, is that mostly the factory disruption or some of these other issues lingering as well?

On the Contractor side, I expect that factory is going to be under some disruption for the balance of the year. We're building that facility out in phases and so we're having to move things like our paint line at some points, we're moving racks around, and so there's some disruption there. Again, our outlook is, is that the topline on Contractor is going to be okay and then operating earnings as a percentage of sales by the end of the year should look like 2018 did, but we may be less leveraged than we would normally get particularly in the first half when it's possible that we could even have some negative incremental margins. So again, I'm not worried about it for the year and I don't think we have anything structurally going on here. But it's a big project we've got going on, and there will be some impacts.

Okay. And then, Pat, you mentioned Europe macro appearing more challenging to get a push in as hard as you tend to earn. But I think you're kind of saying mid-single digits for all the markets. So maybe just bifurcate your comments, with - still sticking with mid-single digits in EMEA.

Yes. I think we can achieve that, but I think we're going to have to make sure that we do a good job with our new product launches and that we're going to have to execute well on the new market initiatives that we've got over there. I just think that there's not going to be - there's not going to be any freebies coming to us from Europe in 2019 from what I can see looking at the macro data.

The good part of it is we have the powder business and the acquired business, which have really nice orders in-house for 2019. So I think that those parts of the business are probably in a little bit better shape than maybe some of the other more legacy businesses that spread across all other regions.

Okay. Thanks guys. I'll get back in queue.

Thank you. Our next question is from Michael Halloran from Baird. Please go ahead.

Hey. Good morning, everyone.

Hi Mike.

Hi Mike.

So on the - thanks for the margin cadence there. Maybe just a similar question on the revenue side, and really applied to all three segments. Any reason that normal seasonality isn't kind of what you've embedded in your guidance? Reason I ask is, obviously the first quarter comp much more difficult than the rest of the year, trends likely slower in the first quarter, just on a year-over-year basis, but I'm guessing the guidance is assuming some level of stability from fourth quarter levels as you work through the year, but wouldn't mind understanding cadence by the three segments for that.

Yes, I think from a seasonality perspective, I don't anticipate anything being significantly different in 2019 than in years past. Obviously, we've had stronger and weaker quarters in 2018 that we're comparing against that can throw a little noise in the number, including our really big first quarter last year. But again, order book, that's coming in here January looks pretty good. And so I think we're off to a decent start for the year and I'm not overly concerned about anything at this point.

No, makes sense and then on the M&A side, anything in the pipeline that's interesting at this point? How would you characterize it? Is it more opportunity, less opportunity as you see it, and any change in how people are trying to value their own businesses?

I'll give you one word, and then Mark can weigh in, but my word is expensive.

Yes, I would echo that. I think that we haven't seen a change in terms of the influx of things that are coming across our desk. But the things that do come across the desk, expectations of value are still quite high. And I would say that we haven't been comfortable moving forward up to those levels. And hopefully, things pull back here a little bit and we can see ourselves involve with some stuff.

No, that makes a lot of sense. Appreciate the time. Thank you.

Yep.

Thank you. Our next question is from Brett Kearney from Gabelli & Company. Please go ahead.

Yes, thanks for taking my question.

Good morning.

Good morning. Thanks for taking my question. I wanted to ask on some of your emerging markets within the Contractor segment's, I know, Q3, you commented some mixed activity levels in Middle East, parts of Africa, some of the other - Russia, some of the countries you operate in there. Just wondering on recent trends and outlook for some of those markets in 2019?

Yes. So I don't want to get too granular in terms of by business unit and product line by country. But for sure, when you look at EMEA, the Middle East has been soft and even emerging markets and the Central East part of Europe have been softer than Western Europe, which up till a couple of years ago, we wouldn't really expected that, we would expected that the higher growth rates would have come out of the East. But at least from Graco standpoint, we're seeing lot better activity in the West and we're having to stretch and claw on the East particularly with the business in the Middle East, which has really been dragging on our overall EMEA results this year.

Okay. Thanks Pat.

Thank you. Our next question is from Walter Liptak. Please go ahead.

Thanks. Good morning.

Good morning.

Good morning.

I wanted to ask about the mid single-digit growth rates, I mean I think, investors, we've been a little bit concerned about some of these macro things going on, international slowing and inflation price cost, it doesn't seem like it's showing up in the mid single-digit growth rates. So I wonder if you can just comment on maybe what you're hearing from your customers. I hear the order book strong good general industrial and maybe is some of this just your own efforts with the new products and work in the channel to grow versus and outperforming the market as a result. Just some color, because there seems to be a little bit of disconnect between sort of the macro headlines and that mid single-digit number.

So, it's always hard to sort out market from Graco's actuals, because obviously playing so many different regions and so many different end markets. It has seemed to be the case here for at least the last six months that we're doing the very best we can to talk ourselves into problems, right. The headlines are negative, all the political back and forth that has been going on has been creating a lot of negativity. In reality, in most of the areas that we're selling, business is good. So there is a bit of a disconnect there from my standpoint. I'll let Mark weigh in with his thoughts.

Yes, and I think that if you look at what we've put up here in the most recent quarter and for the year, with organic growth of 8% ex-currency and ex-acquisitions, I think that really echoes what Pat said about the business tempo being pretty good. We did pull back to the mid single-digit from where we were last year when I think we moved up in Q1 to mid-to-high, and I think we're really comfortable at this point as we sit here that that mid single-digit is a solid number that we can stand behind.

Okay. Great. All right. Thank you very much.

Thank you. Our next question is from Joe Ritchie from Goldman Sachs. Please go ahead.

Thank you. Good morning.

Good morning.

So, Pat, I mean you sound very optimistic on the demand backdrop, which is great to hear. It is definitely in contrast to a lot of other companies that we're talking to specifically in China, auto and electronics. And so, can you just maybe just provide a little bit more color on what you're seeing in those specific end markets? What do you think is really driving your better outlook than maybe some others that we're talking to?

Again, it's always hard to sort out what's happening with the general market vis-a-vis how we're performing in our initiatives, but we take a look at the projects that we're involved with and the projects that we have an opportunity to be involved with in 2019. The project activity still looks good, then we like the product portfolio that we have and we like our new products for 2019. And I think just in general, we don't see a reason at this point be contributing to the doom and gloom.

Okay then, I mean that's good to hear. And I guess either Mark or Caroline, just talking through the mix comments in Industrial, I guess, how long do you expect that to persist and should we expect the incrementals in that business to stay in kind of like that in the 20s for 2019?

Yes, most of the mix in Q4 was driven by a lot of project business, particularly on the powder paint side, which we knew was coming. Good business, we make good money at it. But it is at a little bit of lower margin rate than what they would have normally expected. So it was not a surprise to us. As that mix shifts back to a more normal scenario, I guess, we would expect that the margin rates will come up a bit.

Okay. No, it's fair enough. If I could maybe ask one more, just on the tariffs. What was the impact that you ultimately saw in 2018, and then for the $25 million incremental tariffs and material cost expectations for 2019. Just trying to understand how much of an uptick in the guide is that based on material inflation or your view on tariffs, because it seems like it's a little bit higher than what we were originally thinking for 2019.

Well, I'd say it's pretty much in line with our calculations that we've had. We actually didn't see as much in the second half or in the fourth quarter as we thought that we may earlier on and I'll tribute a lot of that to the efforts of our purchasing team and our manufacturing folks as they work closely with their suppliers to delay it or mitigate it through a variety of actions. So what we saw in the fourth quarter was actually for both material cost change as well as tariffs and I put them together because sometimes it's hard to specifically identify them, it was about $6 million, and based on a full-year estimate, it's closer to then that incremental $25 million for next year.

Okay, got you. Thank you all.

Thank you. [Operator Instructions] Our next question is from Matt Summerville from Davidson. Please go ahead.

Thank you. Just a follow-up on Contractor, the incremental factory-related expenses disruption start-up what have you? Can you maybe quantify how much you anticipate in 2019 and will that continue into 2020 based on the additional bricks and mortar that you're contemplating?

There's a lot of moving pieces. Again, I would just direct you back to. We believe that the outlook for topline in Contractor is pretty decent for 2019. And right now, we project that by the end of the year, our operating earnings as a percentage of sales would look pretty much like 2018. So you can kind of fill around with that however you want, but I think without overly complicating it and trying to estimate things that are going to be hard to estimate. That will be the safest thing for you to do.

And then the only other thing Matt is the factory in the build, now that should be more or less complete by the end of the year with a little bit carrying over into 2020, but I think for purposes of what you're trying to get to, all of this disruption or whatever that you want to call it is really a 2019 event not a 2020 event.

Got it. And then just with respect to pricing, historically you guys have commented that you typically realize somewhere in the range, I believe of 150 basis points to 200 basis points and I clearly understand that you're going to more than offset the $25 million of tariffs. So I can do the math there. I guess more what I'm wondering is, did you make a step function move in pricing in 2019 over 2018 i.e. are we talking to 200 to 250, 250 to 300, can you give us a little bit more granularity on that?

I think you got it right. I think it's a higher price increase just because of the tariff impact and cost pressures that we've got. But in terms of the realization, I think you got the right numbers.

Thank you, guys.

Yep.

Thank you. Our next question is from Saree Boroditsky from Jefferies. Please go ahead.

Thank you. Good morning.

Good morning.

Good morning.

I wanted to dig a little bit more into the performance in APAC Industrials. I noticed you lowered your outlook for autos from favorable to stable. So could you talk about what you are seeing in this market and any difference between project activity versus production?

Yes, so on the production side, about 40% of our Industrial legacy business is parts and accessories. And so based upon unit volume or other measures of output, we can pretty much figure that we're going to get that business. The other 60% of that business tends to be a capital investment to our new product lines that they've got coming out or other kinds of opportunities. That kind of splits that up for you. In terms of automotive, if you just look at the macro data, I think that's really how we get to the stable in the automotive market. Again, we are seeing project activity and opportunities to bid and quote that we think will materialize in 2019. We're definitely not negative about it, but I don't think it's got the same sort of growth potential that it had here a couple years ago when it was increasing more on a unit volume year-over-year.

Makes sense, and then just following up on the M&A question, it's been a few months since you created the New Ventures role. So could you provide any color on any new areas of growth that you're interested in expanding into?

So actually the person that's going to lead that initiative just came back. His responsibilities in EMEA ended at the end of the year and so he is only a few weeks into it at this point. And it is a team effort, although I think he is going to be a strong leader for the initiative. That's just one of the new market opportunities that we're interested in. Obviously, we're pursuing a number of things that we've talked about in the past. We've got a lot more focus on electronics, we're doing quite a bit in sanitary, we're pumping cementitious material, we've got a scarifying initiative running in our Contractor business. So there are a number of other end markets that we are also working on, that are outside of New Ventures that we believe will provide growth opportunities for Graco in the years to come. The New Ventures is just an opportunity to take a talented person who's got good global experience with the company and try to find something else and that's just getting off the ground.

Okay, great. Thanks. It was very helpful.

Thank you. We will now take a final question from Bryan Blair from Oppenheimer. Please go ahead.

Hi, good morning, everyone. Thanks for taking my question. In terms of Process trends, I know that it's difficult to parse out underlying market growth versus share gains, but obviously you are performing very well there. You just mentioned sanitary, I was wondering if you could - you could break out any other applications where you're driving out growth in that segment?

Yes, our Process segment has got a lot of different product lines and end markets mixed in it, and a number of those are small, and obviously, we need to have good market conditions to be successful, but I do believe that our lot of - a lot of our success in the Process segment over last couple of three years has been the fact that we've been executing well on trying to turn smaller businesses into larger businesses, we've got exposure to semiconductor, we've got exposures into the industrial lubrication market there. We've got an Environmental business, it does different kinds of ground water sampling and remediation. So we've got a lot of different end product lines and end markets there, but they do tend to be small. And now we've got initiatives to make them bigger. So certainly I think that that's got an impact.

All right. Thank you very much.

Thank you. If there are no further question, I will now turn the conference over to Pat McHale.

All right, well, thank you everyone for your time this morning, and for those of you that are still on the blast, enjoy the freeze. See you next quarter.

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