Graco Inc (GGG) 2016 Q2 法說會逐字稿

Good morning and welcome to the second-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 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 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 2015 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 obligation to update these statements in light of new information or future events. As a reminder, today's conference is being recorded.

I will now turn the conference over to Caroline Chambers, vice president and 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 second-quarter sales of $348 million, net earnings of $58 million and diluted earnings of $0.89.

Incremental sales from acquired operations contributed 1 percentage point of growth while organic sales at consistent translation rates increased by 3 percentage points as strong growth in the contractor segment more than offset declines in the process segment. A brief reminder for everyone -- second-quarter income last year in 2015 included that investment income of $110 million related to the liquid finishing businesses that were held separate and sold in April 2015.

2015 diluted earnings per share adjusted for the nonrecurring gain were $1.05.

The second-quarter 2015 net income also included $9 million or $0.15 per diluted share related to nonrecurring tax benefits. A reconciliation of our operating earnings is included on page 9 of our slide deck. Gross profit margins this quarter were slightly lower than the rates in the prior year. Favorable effective realized pricing were offset by changes in product mix with a strong growth in the contractor segment and by lower factory volumes this quarter. Operating expenses increased by $10 million as compared to the second quarter last year, of which expenses from the acquired operations totaled $2 million.

We continue to invest in new product development and commercial resources and incremental spending for these initiatives and other corporate items were approximately $2 million in the quarter.

Operating expenses also included $1 million related to new product launches in the contractor segment and $1 million related to warehouse relocation and factory consolidation and integration costs. Unallocated corporate expense increased by $2 million, primarily related to stock compensation and pensions.

For the full year we currently project unallocated corporate expense to be approximately $3 million higher than the full year 2015, primarily due to the increased stock compensation and pension costs. The effective tax rate for the quarter was 31%, up from 28% last year. The rates in the second-quarter 2015 was affected by both the gain on sale of the liquid finishing businesses and the nonrecurring benefit related to a change in assertion as to reinvestment of foreign earnings.

Before Pat provides more discussion on our segments and regions, I will make a brief comment on the effect of foreign currency translation. Foreign-exchange headwinds were minimal in the quarter, reducing operating earnings by less than $1 million and net earnings by approximately $500,000. Foreign-exchange rates have gone somewhat against us since our last quarterly call, but at current rates the year-over-year foreign currency translation impact for the second half of 2016 should be close to zero on the net earnings.

With that I'll turn the call over to Pat.

Thank you. Good morning, everyone. All my comments this morning are on an organic constant currency basis. At 3% organic growth worldwide in Q2, the quarter was slower than expected. Weak topline results in our process segment and industrial Americas is resulting in a reduction in our outlook for 2016, reducing our overall Graco expectation from low to single-digit growth to lower single-digit growth for the full year. Despite the macroeconomic headwinds we believe that there are good opportunities to grow and to generate a nice long-term return for our shareholders.

In order to capitalize on these opportunities to put ourselves in a strong position for when the macro normalizes, we're continuing to invest. We have multiyear initiatives underway and at this point we're continuing to spend in those areas other than to cut and try to maximize quarterly results.

Let's turn to the process segment to talk about the quarter. The business declined teens year over year in Q2, a further degradation from a weak Q1 performance in this segment. All three Graco divisions that make up the process segment were down in Q2, the worst of which being our direct oil and natural gas business, which was off by 1/3 compared to the second quarter last year.

The other Graco divisions in the segment also saw significant declines in sales to oil- and gas-related customers. In absolute dollar terms the process segment was up slightly sequentially from Q1 to Q2.

From an operating earnings perspective, as we discussed in this call last quarter, when sales in the segment are off double digits, the [decremental] margins are going to be high, due to manufacturing volume pressures and other inefficiencies.

Process segment comps get easier in the second half but being off low teens for the first half, we don't expect to be able to get growth in this segment for 2016. It's too much of a hole to make up at this point in the year. If quarterly process segments sales stay in the mid-$60 million range including acquired businesses, I would expect operating margins in the low double digits, similar to the first two quarters of the year.

Moving on to the industrial segment, the industrial segment worldwide posted lower single-digit growth in Q2 and was able to hold its solid operating margins. Performance in Q2 was similar to Q1 with growth in Asia-Pacific, strength in EMEA and a slight decline in the Americas. There was very little variability between product categories in these geographies, which indicates a divergence in the industrial microenvironment, particularly between the Americas and Western Europe. The US is stagnant across categories reflective of weakness in and markets such as heavy equipment, ag, aerospace central controller. Markets that have been strong for the last several years, general industrial, automotive and construction markets, were better than the segment average but are currently soft.

We are seeing cautious customers and a general reluctance to invest capital across most of our end markets.

Moving on to contractor, as expected, contractor had a strong Q2 with high teens growth in the Americas and high single-digit in EMEA. For the first half the business achieved its goal of high single-digit growth in the Americas, and frankly the EMEA region surprised to the upside by outpacing the Americas for the first half by growing midteens.

Profitability for contractor in Q2 was light despite the strong revenue growth. About half the sales increase in the Americas was new product load into the home center channel, which brings the number of load-in expenses and essentially zero operating earnings growth.

There was also incremental spending on engineering, selling and marketing to support our other new product launches that occurred in Q2. Most of the incremental spending for load-ins and product launches are behind us for 2016, so I am expecting incremental contractor margins in the second half to return to the low to mid 30s, similar to our experience rate for the last year and a half.

Contractor sales were solid to both home center and paint store customers. Out the door sales held up on for both channels. Our team is comfortable with the inventory levels in the channel even after the load-in and launches.

We continue to expect the contractor Americas business should continue to achieve high single-digit growth for the full year 2016.

Some brief comments on EMEA -- we had solid high single-digit sales growth in both industrial and contract businesses in EMEA with declines in process taking the overall regional growth down to low single digits. Western Europe grew a little bit better than the average while the emerging market remain flattish. Industrial and contractor growth was relatively broad based across product categories within those segments, while the headwinds in process reflect the factors discussed earlier. As such, we're taking our outlook for EMEA up to low to mid single-digit growth for the full year from our previous view of low single-digit growth.

Asia-Pacific is a similar story in the industrial segment with project activity for technology and automotive as bright spots. China has been driving the performance in 2016.

While the trends have been good, I remain cautious. Asia-Pacific project activity remains highly variable and the numbers can move around from period to period. Contractor business in Asia civic and a week quarter.

Process in Asia-Pacific season similar headwinds as the other regions. At 2% growth year-to-date and just under flat for the quarter, we are holding our Asia-Pacific up for 2016 at a low single-digit growth rate.

Before I summarize the outlook, a quick note on order trends in Q2 -- we started strong in April with orders up double digit year over year. In May, orders were flat. In June, orders were up low single digits versus last year. The Americas region held up best during that period, led by contractor, while the EMEA region of book to bill was slightly less than 1.

While worldwide book to bill was just over 1 during the order, we are bringing about $17 million less in backlog into the second half this year than we did last year, with most of that delta coming from the industrial segment. Recall that the industrial segment had a very strong Q4 last year with a healthy portion of that growth coming from the shipment of projects that were already in our backlog. Our industrial team has their work cut out for them in the second half.

To summarize our updated outlook for 2016, we are taking down our full-year Graco sales growth outlook from low to mid-single digit growth to a new view of low single digit growth. This reflects ongoing headwinds in the process segment and a stagnant growth environment in the industrial Americas.

As it is also reflected in our updated view on the Americas region overall, to low single-digit growth from the previous few of low to mid single-digit growth. We're holding our outlook for the contractor Americas business to grow high single digits for the full year, a pace they achieved in the first half. The EMEA region outlook is increasing from low single digits to low to mid-single digits, reflecting the strength we saw in industrial and contractor in the first half.

The EMEA industrial comps get tougher in the second half, though, so implied in the outlook is a lower rate of growth.

We are holding the Asia-Pacific outlook at low single-digit growth for the full year. We are in a low growth macroeconomic environment with all the attributes that you normally see. Customers are less confident in their businesses, and less willing to invest, which is a drag on our ability to grow in the short term.

We have a culture of continuous improvement and sound expense management throughout the cycle but we also have a strong desire to grow over the long term. As such, we will continue to invest in our strategic initiatives that are in the works and continue to look for more of these opportunities. These initiatives never lend themselves well to working around cyclical upturn from downturns and that can cause some short-term pinch points similar to what we saw in Q2.

We're committed to growth and believe that staying the course will generate the best total return for our shareholders over the long term.

With that, operator, we're ready for questions.

(Operator Instructions) Jeffrey Hammond, KeyBanc Capital Markets.

So you give some good color on margin dynamics and mix and contractor. Can you speak similarly to industrial margins down there a little bit and how you are thinking about incremental margins in the second half for industrial?

This is Christian. Good morning.

What we saw in the first half generally with our industrial segment was decent incremental margins but in the second quarter we did see incremental margins were at a little bit slower pace. As we look at the second half it really has more to do with how you are modeling, what's happening with the topline. We are looking at a very low to low single digit growth rate; the incremental margins are going to be tough just due to the volume pressures that we have.

So we do think we can definitely get incrementals off of sales growth. But from the perspective of having a historical 40% to 50%, that all depends on what you're modeling on topline growth.

Okay. And then just good color on the geographies and your outlook there. Can you maybe split it a different way and just talk about how you see those growth rates by the segments?

Generally, we don't go to that level of detail with regard to our outlook. It's a little bit more than what we want to do.

Yes, we've already got some complex metrics on that. It just gets pretty squirrely if we start cutting it that fine.

That's fine. Just to focus on process, it sounds like, Pat, from your comments you are expecting similar trends in the second half to the first half? Or do you still see --

That's what we're putting into our outlook for now, yes. Frankly, I was just wanted in process in the second quarter, not so much on the oil and gas business, which I figured was going to be down. But we did a little poorer than I expected on the organizations that are within that segment. Now, they do have some oil and gas exposure and those got hit pretty hard, but overall the process was a little bit softer than I expected here through the first half. And we have modeled that into our outlook for the second half.

Okay, perfect. Thanks, guys.

Matt Summerville, Olympic Global Advisors.

A couple questions -- just to get back to Jeff's comment on the process side of the business, is there a market share issue? Is there a market dynamics that is occurring in the non-oil and gas related as this is that you had not been anticipating? What, 90 days ago, led you to conclude that you're going to see inflection in that business and what's changed to lead you to conclude that you are not, anymore?

When we started year, even through the first quarter we still thought that we could rally the last nine months of the year and post growth in the process segment despite what we were seeing. At that point I wasn't expecting weakness that we've seen in some of our -- I'll say standard diaphragm pump type businesses and specifically in our PMG business in lubrication.

Those have some exposure to oil and gas but it's fairly limited and I expected better performance out of those areas that we've seen. Given the fact that the year is half over I think we would be remiss to communicate to you that we think we can make up the whole in the second half of the year.

Got it. And just a follow-up back to industrial Americas -- you mentioned in your prepared remarks you are basically seeing softness across most categories here in the US, and you even mentioned construction in that same sentence, if you will.

Is there a bifurcation between what you are seeing in the construction-related demand or end markets that impacts the industrial business versus what you are seeing in contractors? Can you close that gap?

Yes, I'd say there definitely has been a little bit of a bifurcation there. I don't have an exact explanation for why. But I can tell you that on the industrial side the products are generally much more complex and expensive, so we are talking about much more major capital investments on a CD sprayer. And just given -- again, this is not based on any sort of a market survey -- but given what we're seeing with customers in cautious about CapEx spending, I think that is likely pressuring the higher contractor type construction products that are embedded within our industrial business.

Got it. Thanks, guys.

Mike Halloran, Robert W. Baird.

So staying on the industrial side there, is the thought process as you work through the second half of the year in America just continued stability? Any deterioration baked in? And also what kind of catalysts are out there, what kind of catalysts do we need to come through to start seeing some improvement in those markets from your perspective?

We didn't bake any deterioration in it. I'd say really our outlook for industrial in the Americas in the second half is similar to the first half. There are some things that could swing that either direction. I think the macro is hard to predict right now. A lot of it that I see, I think, is confident space.

It's not that the pipeline is drying up. There's projects out there and there's activity. It's just that we just don't see people as eager to spend on capital right now. I really think that, partly, I think you are seeing is the companies are not growing, so when they are not growing that doesn't drive them to need to put capital in for capacity expansion.

But over and above that, even projects that are cost reduction and quality improvements when companies are suffering on the topline, they tend to take a more conservative view. So I think we are seeing some of that. And I can't really tell you from my contacts and what I read and see out there that there is any clear catalyst that is going to swing that one way or another in the short term. There probably is, but I'm not smart enough to see it.

I understand. And then on the contractor side it sounds like that is playing out as you guys expected. As we get to the third quarter or fourth quarter, maybe just talk a little bit about channel inventory, if there's anything interesting going on in the mix side. And then lastly there if there's any carrythrough on the new products like, any new product launching in the third quarter, if that's mostly behind you in the second?

Most of the products launched behind us although we are seeing good sellthrough on the products that we launched and feel pretty good about our opportunities in the second half. They need to have a good third quarter. If you remember last year, they had a pretty big fourth quarter.

So in order to achieve our number for the year we did see some decent performance in the third quarter. But again, out the door sales in both channels have been good. The new product that we launched in the second quarter has been well-received, so I am expecting that we are going to have some sellthrough and the team is feeling pretty confident that they are going to be able to deliver the year here as they expected.

Thanks, guys.

Kevin Maczka, BB&T Capital Markets.

Pat, as we look at slide nine I was just trying to get a sense for which of these items that impacted Q2 will also impact the second half and which won't. I think you said -- product launch is something that's happening all the time but it sounds like the bigger cost there is behind you and maybe the facility relocation as well.

Can you just touch on those? Are things like this pension and stock comp and some of these other items continuing to the second half to give you headwind?

So I'll let Carolyn and Christian comment on the corporate expenses. In terms of operational and commercial that we've got going on, we are continuing on with some facility relocation and consolidations. So some of that is going to still spill into the second half. We got things happening within the process segment with a couple of the different acquisitions that we've done that we're doing consolidation. It should be a nice long-term payback on that, but in the short term that will continue to put some expense pressure on us.

In contractor, in particular, I'd say the big lump of launch cost associated with 2016 product is behind us. We should still continue to see some engineering expenses in the second half related to 2017 plan launches that we have. You might be able to take a little bit of that back, but I think you would be wise to leave some of that in.

When we're looking at some of the corporate costs and we are thinking about pension and the stock compensation and basically we've seen some of the work coming in as we look at performance on assets and so forth that have just -- a little heavier load in the first half and we won't be able to make up for that in the second half.

That was our updated rejection on unallocated corporate, at about $3 million higher than last.

Okay, got it, got it. And then if we just shift over, Pat, to some of the comments you made about some of what have been solid industrial markets softening up, you specifically mentioned auto. Can you give us a little bit more color around that and the other market that you mentioned as well?

Yes. That was really not a comment necessarily that the pipeline is drying up and that they are not willing to spend any money. But it's just much more caution and much more -- I'd say people are taking more time to make decisions on CapEx projects than they probably what have here a year ago.

Remember we are still seeing pretty good activity in the fourth quarter last year coming out of the segments and customers with a willingness to invest. It really seems like in the last six months things have slowed a little bit.

Again, it's not dramatic and I'm not predicting anything to fall off a cliff. But definitely in the last six months the environment has gotten a little softer from my standpoint, rather than better.

Okay, great. Thank you.

Charley Brady, SunTrust Robinson Humphrey.

Pat, just a question on the contractor business. I just want to make sure I understand the margin expectation going into the second half. A load cost -- are there additional load costs going into Q3? And would you expect --? I think you talked about getting back to that mid-30s incremental in the second half. Is that a fair expectation?

This is Christian. Yes, that was exactly Pat's comment, which is mostly that low-cost is behind us. We're not expecting we're going to have any large incremental spend around that.

So that really -- we got through it in Q2. As we look at the second half we should have been more -- we do have a mix we are dealing with where in the last year and a half or so with more home center than -- not more home center but a higher proportion of home center mix than we had historically, which takes us down into those incrementals that are in the low to mid 30s.

Can you give us a sense on the mix issue, home center versus [propane], what that mix looks like today versus maybe what it was a year ago?

We don't disclose that level of detail around that business just due to competitive concerns.

Fair enough. Industrial margins -- if you look at second half versus second half last year and even first half of this year, given the performance you've seen seeing in the Americas, do you see that margin being up year over year or sequentially from second half -- from first half, sorry?

It really depends on how you look at the growth rate but I think when we are talking about the growth rate that we are looking at right now, it's tough to see much expansion in that margin.

Got it, thanks.

Joe Ritchie, Goldman Sachs.

Maybe touching base on the industrial segment again, EMEA -- you guys did have really good growth this quarter. You took up a growth forecast for EMEA for the year as well. Maybe some more color on what you're seeing in the regions and whether you have any concerns as it relates to Brexit?

Other than the impact on currency I'm not sure I expect anything too dramatic out of Brexit here, coming on the second half of the year. That business in EMEA in general, if you look across the product categories, on the industrial side it has been pretty broad based, it's not just one product category that we are doing well in. We are doing fairly well across the product categories.

So I think it's indicative of improving, at least improved conditions in EMEA this year over where we were a couple of years ago.

Okay. And just maybe sticking on the Brexit for a second, what is your exposure to the UK?

4% of our sales are in British pounds.

And maybe one last question, just going back to process. Clearly the trends have worsened from what we expected earlier this year.

Is there anything you can do internally to help drive better performance out of the businesses in light of how we -- the environment is?

This is a challenge that we have. Of course, I don't like delivering numbers like this either. I can go back through all the things that we are working on and I look at and I say, are these the right things to be doing over the longer term? I have a list and I go through every single one of them. Some of them are losing money today and I could cut those out and we could quit losing money on them. But they are definitely the right to be doing.

So we are just going to batter the storm here a while. I think in the end we're going to come out ahead. But we are consolidating a number of facilities within the process segment. I suppose we could stop doing that and the quarter might look better. But the facility consolidation is going to lead the quality improvements and cost reductions and lots of benefits down the road.

We've got new equipment going in to facilities, which drives indirect labor and it drives tooling cost. That new equipment also has cost reductions, so that the cost and the benefit don't necessarily line up at the same time.

We are investing in new sales teams to chase particular products that we've launched recently, and the sales team and cost of the sales team is bigger than the initial revenue. So we got a number of things like that. I look at them and I say, I could make more the quarter look better, and I could get some leverage if I cut those things. But where is that going to leave us in two or three years?

So right now, given the fact that the world is just a little soft and it's not a disaster, my mindset is that we are just going to take our beating. We're going to keep going and we're going to come out ahead.

Thanks for the color, Pat.

Walter Liptak, Seaport Global Securities.

I wanted to ask about pricing and maybe starting with your oil and gas exposure. And if you are seeing any incremental pricing pressure or how you are dealing with pricing coming from the projects.

So let me talk about pricing in general across Graco first and then if Christian has detail he wants to share specifically on the oil and gas stuff, he can do that.

Price/cost has been okay this year. And when I talk about cost I'm really talking about material cost.

So that equation is working for us. In most of our product categories, we got our typical annual price increase and on the material cost side we are still doing fine, compared to last year.

Of course, there are some projects and things where we get pressure from time to time but our bigger issue really on the gross margin side isn't a price or material cost issue, it's more the fact that we've got some pretty significant reductions in a couple of our business units, which is leading to factories that are slow. And we have slow factories that puts a fair amount of pressure on our gross margins. So we're trying to manage through that presently.

With regard to pricing in oil and natural gas particular, that portion of our process segment -- you are right, it's a difficult environment in order to get pricing. We feel like that's stable right now. We are not really, for the most part, giving up pricing.

Okay, great. And then pricing in the industrial business -- you are talking about customers taking more time. Are they pushing pricing or is this just the ROI projects that they are just not sure they're going to have or not?

No, the price environment has been okay in industrial. We haven't seen any real impact there. Most of the projects that we are selling, if they are not for capacity, there is an ROI. Of course, we always have to be cognizant of what our pricing levels are so customers can get an ROI. We are not necessarily see or expecting significant pricing issues coming out of the industrial side.

Okay, great. And then aren't some of those projects more back half loaded, anyways? Typically like there's budgets that are put in place and there's concern about your Brexit or whatever, maybe it pushes a little bit. Is there still some hope that you could have a better second half?

Yes. I don't want to make it sound like today that we are giving up hope. But we want to be realistic and we don't want to sit here and tell you that everything is going to be rosy in the second half.

We've got our new products that were launched and we've got our initiatives that we are chasing and we don't know what's going to happen globally in the geopolitical environment in the second half. So we definitely as a group have not given up on the second half but what we are trying to do is communicate that from a realistic viewpoint, you probably ought to think about the second half on industrial more like the first half and on some hockey stick is based upon a dream.

Okay, fair enough. And then just to follow up on that productivity question, it sounds like with these new sales, investment and new equipment going in I wonder if you could quantify what those costs are. And I'm thinking mostly about the factory consolidations with some of the acquisitions that were done.

How much flow-through the P&L in the second quarter, how much more of that incremental cost goes through in the background?

So, I would refer you to page 9. We don't really want to break it out in more fine detail than that. If I start taking 10 projects and breaking out the detail in each one that I have to give updates on each one every quarter and we would give out information to a variety of folks that we don't necessarily want to give information to. So I'd refer you back to page 9.

And again, in terms of what is going to spill into the second half, there are still going to be factory relocation new machine costs that are going to be in this second half, maybe slightly favorable to the first half. But I certainly wouldn't zero those out, and I think Caroline can restate our comments on the corporate side.

Yes. Once again we saw a few things coming through but they are basically -- we are projecting similar in the second half to the first half.

Okay, thank you.

Jim Foung, Gabelli & Company.

So you talked about the process business that in the second half is going to be better than the first half. So could you just -- are you getting this sense that you might be near the bottom or close to it in the process business with the oil and gas products?

With regard to the bottom, Jim, I think that's going to be hard for us. We are not the economists that are going to be able to make that call.

At the same time, when we look at Q1-Q2 sales we are essentially flat between the business at the mid-60 range. So again in the process segment overall.

So do we think it's stabilized? Yes, I think it has stabilized. Bookings were at a similar level to the billing side. So we are feeling okay about that.

The real question is what happens to the comps that we have. And the comp is a little bit easier in Q3 and it gets a little bit harder in Q4.

Okay. And then the oil and gas industry continues to be weak but then seeing some in 2017. Maybe you could just talk about your outlook in terms of more properties in this space as you get close to getting out of the downturn as you go into 2017?

Yes. So when we started our initiative on building some exposure to oil and gas we took a two-pronged approach.

One was, we put together engineering team and we created a business unit and we identified the product we are interested in and we started organic development. And that continues.

So going into 2017 we will continue to expand the product range that we have of products that are designed by Graco, manufactured by Graco. In terms of the acquisition front, we understand the spaces that we want to be in and we have a pretty good list of players in those places. We continue to try to keep channels of communication open. Whether anything happens next year or not I have no idea. At the right price for the right property we are still in the game.

Right. And it seems like anything you buy at current prices would be accretive in a couple years from now.

Yes, although we typically like to buy companies that we believe can be Graco-like in the future. And companies that can be Graco-like, generally don't get fire sell. So we have plenty of companies that we like to buy at a certain price. But just because the market is depressed those owners aren't looking to do a fire sale.

I think it would be great if it happens but I'm not anticipating buying great companies at rock-bottom prices and getting a short, real quick accretive payback on. It would be nice but I just don't see for the kinds of niches and SSO we are looking at.

Okay, great. Thanks.

(Operator Instructions) Jim Giannakouros, Oppenheimer & Co.

Industrial Americas versus contractor segment -- if I understood you correctly, the bifurcation as you saw it, bigger versus smaller ticket items, can you give some color on what you are seeing, if you just cut it a little differently just by residential versus commercial markets in the cycles there?

Yes, it's really tough. Our view is both markets are pretty decent right now. But when you sell a paint sprayer or texture machine into a channel partner and then they sell it to a contractor, there's no way for us to really know exactly what they're using that product for. Generally, the larger products are used on the larger jobs and the smaller products are used on the smaller jobs. But to be able to really figure out from a Graco perspective whether it's going residential or commercial, that becomes pretty tricky. So we generally don't try to guess on that. But both markets look they are pretty decent right now, I'd say.

Thanks. And one follow-up, if I may. I'm just trying to gauge how incremental margins are trending. Can you speak to just internal initiatives on plant efficiencies? Historically it has been a nice offset in the price/cost equation, understanding the market pressures that you have now and the continued investment with what you are doing internally in the facilities that you are running, the blocking and tackling, etc. How much of an offset, or is this a year where that's not a major contributor?

Know. In the factories that are struggling for volume is going to be difficult. We are doing all the same things that we always do. We've got cost reduction project, quality improvement projects, capital equipment going in. But where we have volume challenges it's just difficult for that to work.

So on factories like a contractor equipment, where we are still seeing volume, there's still opportunities there for that group to do some offsetting. And we look for a strong second half, hopefully, out of the team up there. But in some of the other factories that are really slow, rates go up because you get rid of your temporary laborers and you have your full-time laborers.

It's hard to get a justification on new equipment because you are trying to justify it on lower volumes. So it definitely is putting a strain on us and you are seeing that reflected in our gross margins in the first half. So unless we see a change by probably at least a couple or 3 points in our overall growth rate going into the second half our factories are definitely going to be challenged this year.

Understood. That's all I had. Thanks, Pat.

Marc Heilweil, Gratus Capital.

I wonder -- I need a little education on the process side of the business. So first, what is the average selling price for process equipment as opposed to industrial?

Sure. That's a pretty broad question. We've got three different Graco indications in there. Generally, unit selling price in process is less than the unit selling price in industrial.

But that's a pretty difficult comparison to make, given that the applications are so different. For example, our direct oil and gas business is heavily focused on valves. And certainly the selling price of a single file versus a piece of complex equipment that's going to do painting inside of a factory -- there's not really a lot of comparison there.

Parts of our process business include our double diaphragm pumps, which, again, don't have a particularly high initial investment cost and lubrication equipment, again, which is fairly low from a hyphenated standpoint. Regardless of the fact that they are low on a per-unit selling basis, a lot of that activity across those business units is driven by projects. So you may have to think about it a little bit differently.

It could be a $300,000 project made up of a bunch of lower-priced Graco product and all sorts of other companies' product put into a system. And the customer's decision doesn't necessarily have to do with what they pay per unit or a piece of Graco but it's whether this entire project that they want to do that would include quantities of our equipment is actually going to get done, if that makes any sense to you.

It makes a lot of sense, thanks. And then on the process side, a twofold question -- what is the pace of innovation possible on the process side as compared to some of your others? It has always been Graco's strength. Is there a slower rate of acceptance and introduction of newer products?

And secondly, I think you may have dodged the question a little bit that was asked earlier. Can you give us a broad view of the competitive landscape on the process side? Has it gotten a little tougher? Or are these just macro issues that you're doing with?

You are right; I didn't answer but I did it because I forgot, not because I was trying to dodge. So thanks for reminding me. My view on the process business for Graco is that currently in going forward we are going to be a share taker, not a share loser. We have decided to build a business around process that was small or didn't exist for Graco before.

So as we grow that segment, we're going to be taken business from others. So I don't view that as a situation where we've got market share problems. I think people are going to need to watch out for us over the course of the next five or 10 years in that space.

So hopefully that answered that. And I don't see any changes in any of our business units there that have me concerned from a market share standpoint.

In terms of your question on the pace of innovation, we are trying to build capability and capacity within the business units that we have in our new process segment to drive innovation. We are definitely not where we can be yet from that standpoint. The oil and gas team is only about three years old. The process group that we've got within there is a new group as well and then we got some acquisitions.

So I think there is some nice opportunity. Again, if you're taking a longer term view of what we can do with that business I think there are some nice opportunities for us to improve the pace of innovation in those markets. I think, generally, customers will accept it.

There are some markets where it's probably going to take more time to get products seeded because of testing requirements, for example, some oil and gas applications where products need to be well-tested and specify. But I think the general model works in that space and it's one of the reasons that we have targeted that for growth. We think that's a strength of ours and we can leverage it into process in the future.

Terrific. Thanks very much for your sound management and your hard work.

Charley Brady, SunTrust Robinson Humphrey.

Just a follow-up on contractor. I want to make sure I'm clear on your comment in the second quarter. Did I hear you correctly that half of that [$16] million incremental revenue dollars was the loading of product?

Yes, approximately.

So that's kind of a one-in load? And there's not additional loading going into the second half, or am I incorrect on that?

No, but we will get sellthrough.

Okay. I wanted to clarify that. Thanks.

Jeffrey Matthews, Ram Partners.

Two follow-ups -- one, as Pat said, you're cautious on China. And I wonder why. And in a sort of related question -- you talk about a lack of confidence in CapEx, the Company holding back. I get that industrial production isn't as strong is it could be. But what else is that they are looking for to pull the trigger on CapEx? When you talk to other customers what are they waiting for to see?

So, the first question about cautious on China, actually China was pretty strong for us here in the second quarter. My caution is more Asia-Pacific in general and it's for Graco results quarter to quarter because we still have significant exposure to some projects in our Asia-Pacific number. And so, from one quarter to another we can go up and down. It's not really reflective of a trend so that's really what I was trying to communicate. It wasn't any particular fear there but just that we can have a good quarter, we can have a not so good quarter, depending on the timing of projects in an environment where we're not going out double digits every quarter.

In terms of CapEx spending what our customers are looking for, the customers that are doing okay themselves, generally if you can show a solid cost reduction or quality improvement or if they are launching a new product and the need to make a process change you can get them to open up their wallet. It's certainly not like everybody quit spending, because their sales are about the same that they were last year, which is a lot of sales.

But it's just -- it's on the margins and the difference between getting mid-single-digit growth and being flat is not a large number of orders.

Certainly, as I mentioned before, from a capacity expansion standpoint, companies don't have the pressure that they would when we would be in a robust economic situation. So that's part A.

And part B is as people are struggling to maintain results in an environment where they are not getting much topline growth, they are being very mindful of how they are spending their dollars. And CFOs and other folks in the financial are getting involved and slowing the process down a little bit. So that's really what I see.

But again, that's commentary. There's not any market research behind it.

It's better than market research, believe me. Thanks very much.

That concludes today's question-and-answer session. I will now turn the conference over to Pat McHale.

Thank you, everyone. Obviously not a great quarter. We are not particularly pleased. I hope, in addition to our reality check for what we think may happen in the second half, you also take away that there are plenty of good things that we continue to work on. We are excited about what we think we can do with the Company going forward. This is not a great time but we will get through it. We're going to come out the other end stronger.

So carry on and we'll talk to you in three months.

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