宣偉 (SHW) 2003 Q3 法說會逐字稿

Good morning and welcome to the Sherwin-Williams Company's third quarter 2003 earnings results conference call. Today's call is being recorded. At this time for opening remarks, I would like to turn the call over to Conway Ivy, (technical difficulty) Corporate Planning and Development. After his remarks, Chris Connor, Chairman and Chief Executive Officer; Sean Hennessy, Chief Financial Officer; John Ault, Vice President and Corporate Controller; and Bob Wells, Vice President, Corporate Planning and Communications, will be available for questions. Please go ahead, sir.

Thank you. Good morning everyone and thank you for joining us today for our review of the third quarter 2003 results and our expectations for the fourth quarter and full year. This conference call is being webcast simultaneously in listen-only mode by Vcall over the Internet at www.sherwin.com. An archived replay of this webcast will be available approximately two hours after this conference call concludes. It can be accessed at www.sherwin.com and will be available until Thursday November 6, 2003 at 5 PM Eastern time.

Before proceeding, I would like to remind you that during this conference call, we will make certain forward-looking statements as defined under U.S. federal securities laws with respect to sales, earnings and other matters. These forward-looking statements are based upon management's current expectations, estimates, assumptions, and beliefs concerning future events and conditions. Listeners are cautioned not to place undue reliance on any forward-looking statement. Forward-looking statements are necessarily subject to risk, uncertainty and other factors, many of which are outside of the control of the company, and these could cause actual results to differ materially from such statements and from the Company's historical results and experience.

A discussion of these risks, uncertainties, and other factors are described from time to time in the Company's reports filed with the Securities and Exchange Commission. Any forward-looking statement that speaks only as of the date on which such statement is made, and the Company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events, or otherwise. After the review of our third quarter results, we will open this session to questions. In order to allow more time for questions, we have provided balance sheet items and other statistical data on our website, www.sherwin.com, under investor relations third quarter press release.

I will begin by summarizing the overall Company performance for the third quarter of 2003 versus the third quarter of 2002. Net sales increased 5.4 percent to $1.5 billion. This result was favorably impacted by strengthening domestic architectural paint sales to contractors and continuing positive momentum in the DIY market. Excluding the effects of currency exchange fluctuations relative to last year, consolidated net sales increased 5 percent for the quarter. Consolidated (technical difficulty) increased 33.4 million for the quarter. Gross margin of 45.2 percent was the same as the third quarter (technical difficulty).

In spite of a reduction in the net pension credit of approximately 6 million before income taxes, third-quarter SG&A as a percent to sales decreased from 32 percent in 2002 to 31.9 percent this year. This was primarily due to the improvement in sales. Interest expense remained flat in the third quarter of 2003 versus the third quarter of 2002. Other expense net decreased (technical difficulty) quarter of 2003 compared to last year. This was primarily due to stabilizing foreign currencies, which resulted in a foreign currency related gain during the quarter compared to a loss last year. Net income increased by $9 million, or 8.1 percent, to 120.3 million from 111.3 million in the third quarter of 2002. This increase was due primarily to the improvement in sales and reduced tax rate, which was partially offset by a $3.8 million after-tax reduction in the net pension credit. Diluted net (technical difficulty) common share for the quarter was 82 cents per share, compared to 73 cents in 2002.

I will now review our performance by segment for the third quarter of this year versus last year. Sales for our Paint Store Segment in the third quarter increased 5.4 percent to $989 million. Comparable store sales, which are sales by stores open more than 12 calendar months, grew 4.5 percent. Sales growth for our stores was driven primarily by higher volume architectural paint sales to both professional and DIY customers. This strength in architectural paint sales more than offset continued weakness in our product finishes business. In the third quarter of 2003, we began to see some early signs of improvement in the market for industrial maintenance products. Although these signs do not constitute a trend, we are guardedly optimistic about the prospect for improving business in this segment.

Our chemical coatings business achieved flat sales for the quarter compared to last year's third quarter. Sales of products to the wood finishing market were up for the quarter, but sales to most plastic and metal finishers remained down, a reflection of market conditions in these segments. Although during the quarter, we saw some improvement in the stability of some markets, we are not ready to conclude that this market has bottomed out. Regionally, in the third quarter of 2003, our Midwestern division led sales performance, followed by the Southeastern division, Southwestern division, and Eastern division. Operating profit for the segment increased 7/10 (ph) of a percent to $141 million in the third quarter 2003. Operating profit was adversely affected by a reduction in the net pension credit, continuing increases in health care cost, and the segment's continuing investment in the Asia-Pacific market. Combined, these factors reduced the segment's third quarter operating profit by approximately $5.5 million.

The Paint Store Group ended the quarter with 2671 stores in operation. This compares to 2624 stores at the end of the third quarter of last year. During the third quarter, we added 13 net new stores. Year-to-date, through September 2003, we have added 28 net new stores, none by acquisition. For the calendar 2003 year, Paint Stores Group remains on track to add approximately 50 net new stores. Also, during the quarter, we refreshed 123 stores. Year-to-date, we have refreshed 440 stores, on pace to complete our entire chain by year-end 2004.

Turning now to the Consumer Segment for the third quarter of 2003, sales increased 4.7 percent to $328.9 million. Sales for the Consumer Segment benefited from stronger architectural sales at several of the segment's large retail customers and from increased sales of aerosol paint and wood care products. Operating profit for the Consumer Segment increased 5.3 percent in the quarter to 63.4 million, from $60.2 million last year. Operating profit improved compared to last year due primarily to increased sales through both external customers and the Paint Store Segment. It also improved due to manufacturing efficiencies related to this sales volume and tight expense control. These factors more than offset the reduction in net pension credit.

Turning now to our Automotive Finishes Segment in the third quarter. Sales in U.S. dollars increased 1.2 percent to $115.1 million. This improvement resulted primarily from sales generated by the segment's international operating units. For the quarter, currency exchange fluctuations had an insignificant (technical difficulty). Operating profit for the quarter in this segment decreased to 12.4 million from 13.2 million in the third quarter last year. This segment's (indiscernible) profit was negatively impacted by the effect of weak domestic sales volume on operating efficiencies and the reduction in net pension credit compared to last year.

Going now to our International Coatings Segment in the third quarter, sales in South America improved compared to last year, although market demand for architectural products and OEM product finishes in the region continued to be somewhat constrained. Sales in the UK were strong compared to a year ago. Third quarter net sales for the segment in U.S. dollars grew 17.1 percent to $68.2 million. Excluding the effects of favorable currency exchange fluctuations relative to last year, sales for the quarter increased 12.6 percent. Operating profit for the quarter in U.S. dollars was 3.2 million, compared to a loss of 300,000 in the third quarter of 2002. The operating profit for this segment was bolstered by the favorable effect of improving currency exchange rates on the relative cost of dollar-denominated raw materials.

I would like to now comment briefly on our balance sheet cash-related items. During the third quarter, our working capital management improved. Inventory days declined year-over-year from 83 days to 81 days. Accounts receivable declined year-over-year from 52 days to 50 days. Our working capital ratio -- that is accounts receivable plus inventories less payables to sales -- came in at 13.5 percent versus 13.7 percent for the third quarter 2002. These calculations are based on 12 month sales and average of working capital. Our total debt on September 30, 2003, was $516.7 million. Total borrowings to capitalization were 26.5 percent at the end of the quarter (ph) versus 28.1 percent at the end of the third quarter 2002. We expect our total debt to capitalization to be approximately 26.5 percent at the end of 2003.

In the third quarter of 2003, our Company purchased 1,472,045 shares of its common stock in the open market. At September 30, the Company had authorization to purchase approximately 5.3 million shares of its common stock. We expect to continue (technical difficulty) our opportunistic purchases of Company stock for treasury, since we continue to believe our stock is a good value. In the third quarter 2003, we spent $25.8 million on capital expenditures. Depreciation expense was 26.4 million, and amortization expense was 2.9 million. For the full year, 2003, we would expect the capital expenditures will be approximately $115 million. The predominant share of these capital expenditures will continue to go towards expanding our store network, plant productivity improvements, and distribution infrastructure. Depreciation will be about $108 million versus 103.7 million in 2002. Amortization will be 11.9 million versus 12 million in 2002. Additional financial information is available on our website under sherwin.com investor relations press releases.

As I usually do, I would like to now give you a brief update on the status of our lead litigation. In our second quarter conference call, we informed you that the court in Rhode Island has scheduled a retrial to commence on April 5, 2004. It is our understanding that the case will proceed in a similar fashion to the initial trial. Phase I of the trial will again (technical difficulty) to the sole issue of whether lead paint in buildings is a public nuisance. Aspects of future trial phases after the completion of the retrial of Phase I are still being considered by the court. As a reminder, the Rhode Island case was the first legal proceeding against the Company to go to trial related to the Company's lead pigment litigation, which has been ongoing since 1987.

Several legal proceedings pending in other jurisdictions had trial dates set for 2003. It has been our policy in these calls to keep you informed of the status of any lead suits pending against the Company that have been set for trial. Of the personal injury cases pending in Mississippi, the Gaines case was the first scheduled for trial. It was to be done in June of 2003. The judge dismissed the case in early June. A reconsideration motion was filed by the plaintiffs, and that was denied by the judge. The plaintiff appealed the dismissal. Three adult painter cases filed in Mississippi are scheduled for trial in February and June of 2004.

During the summer and early fall, three more public nuisance cases were dismissed. These were the in city of Milwaukee, Santa Clara County, California, and the city of Chicago. A case pending in the state of New Jersey was dismissed earlier in 2003. The cases in St. Louis, New York City, and Rhode Island are still pending. In St. Louis, the defendants have filed a motion to dismiss. The New Jersey and Santa Clara cases are on appeal by the plaintiffs. Milwaukee and Chicago have not yet indicated their intentions to appeal. As a reminder, to date, we have had less than 100 lead litigation cases filed since 1987. Excluding the most recent cases, over 85 percent have been dismissed. None have ever been settled. Only one -- that is Rhode Island -- has ever come to trial.

This completes my review of our results for the third quarter of 2003. Now I would like to turn the session over to Chris Connor, who will make some general comments and highlight our expectations for the fourth quarter and full year. After that, we will then open the call to questions. Chris.

Thank you, Conway, and good morning everybody and thanks again for joining us. In summary, I would say the third quarter was a solid quarter for Company. On the sales front, we are encouraged to see a number of our programs and initiatives beginning to pay off, which helped us to register (technical difficulty) mid single digit gains. Despite the drag on earnings from a reduction in the net pension credit that we've talked about over the past few quarters, we were able to convert this 5.4 percent sales gain into an 8.1 percent profit improvement and an earnings per share increase of better than 12 percent.

While it has been (technical difficulty) for us to seen an improving trend in our sales performance, it has not diminished our focus on the operation side of our business. Again, during the past quarter, we continue to (technical difficulty) controlling costs, managing our working capital, and further strengthening our balance sheet. For several consecutive quarters now, we have been talking about and reporting strong architectural sales through our stores, and this quarter is no exception. Sales of architectural products to both professional users and do-it-yourself customers continue to generate strong year-over-year growth. In recent months, we've also seen signs of vitality slowly returning to some segments of the industrial maintenance market. Industrial maintenance sales volume was up in the quarter year-over-year, with the strongest increase coming in September. Many industrial contractor customers also report a slight pickup in bidding activity in recent months. Yet, despite these positive signs, we do expect spending in the industrial maintenance market to remain somewhat constrained for the foreseeable future. In this environment, we believe our new and emerging product technologies, like the Express Tech (ph) line, a fast-cure, rapid return to service product, will enable us to capture market share from conventional slower peer products.

Turning to our Consumer Segment for a moment, the Dutch Boy twist-and-pour program continues to gain momentum at key retail accounts. Third quarter twist-and-pour volume grew sequentially over the second quarter, a reflection of growing consumer acceptance that continues to drive stronger out-the-door sales. We expect the fourth quarter sales comparison to be tempered somewhat by the (technical difficulty) that occurred in the fourth quarter of last year. We've commented in the past about the success of this new container and expanding distribution for the Dutch Boy brand. Recently, Ace Hardware Stores announced that they would be adding two lines of Pratt and Lambert brand paints in the twist-and-pour container to their paint offering. The program was unveiled to Ace retailers at their fall convention last week, and we expect sales to ramp up slowly over the coming year. Notably, this is the first time that Ace has offered an alternative to their own Ace branded paint line through their 15 retail support centers. Needless to say, we're delighted to be partnering with such a well-respected, quality organization.

Our international segment also turned in a stronger performance in the third quarter, improving sales trends in many South American (technical difficulty) gross sales of local currency up by more than 12 percent over the third quarter of last year, and favorable currency exchange added about another 5 percent for us. Operating profit for the segment grew by 3.5 million, or 3.1 million if you back out the effect of currency exchange. This profit improvement resulted from increased sales, line related manufacturing efficiencies and a lean cost structure.

Before I turn to our expectations for the fourth quarter and the year, I would like to comment briefly on our use of cash. As Conway indicated, we continued to purchase our stock in the open market for treasury during the third quarter, retiring just shy of 1.5m shares, which brings our year-to-date purchases to around 5 million shares; and as Conley also mentioned, our remaining authorization at September 30th at 5.3 million shares. On October 24th, last week, our Board of Directors canceled the remaining 5.3 million share authorization and issued a new authorization to purchase 20 million shares. This action will ensure our ability to respond to future buying opportunities as we continue to believe our stock is undervalued (technical difficulty) represent a good use of our cash for our shareholders. Also, at this meeting, our Board declared a regular quarterly dividend of $0.155 cents, keeping us (technical difficulty) towards a 62 cent dividend for the year, which will mark our 24th consecutive year of increased dividends.

Looking ahead, we anticipate that fourth quarter sales will increase in the mid- to single-digit range versus last year's fourth quarter. With sales growth at that level, we expect diluted net income per common share for the fourth quarter will be in the range of 39 cents to 47 cents per share compared to 38 cents per share for the last year's fourth quarter. Back on July 22nd, we commented that we expected our annual sales would increase 1.5 to 3 percent over 2002. With the relatively strong third quarter we have had, we now expect our annual sales will finish between 2.5 and 3.5 percent over 2002. With anticipated annual sales in this range, we expect a diluted net income per common share for the year will be in the range of $2.16 to $2.24 per share, compared to $2.04 per share last year before the cumulative effect of change in accounting principle.

Planning for our 2004 year is currently in progress, and we will be prepared to provide you with sales and earnings expectations for next year during our year-end 2003 conference call. At this time, Conway, Sean, John, Bob and I would be happy to take your questions.

a question-and-answer session will be conducted electronically today. (OPERATOR INSTRUCTIONS) Eric Bosshard.

A couple things. First of all, can you give us a little sense -- I think you commented in regards to chemical, but sales momentum in the quarter into September and then what you've seen through the first couple weeks of October?

In terms of the company, July was good. August was the weakest sales month, September was very good, and we see that through the first few weeks of October. The performance in September is continuing into October so far.

Within that, is that momentum across all businesses, is it -- give us a little more color on where you are seeing the improvement taking place.

I think those -- that characterization of what was happening July, August, and September would apply to all of the segments. But, obviously at different rates.

Second question in the Stores segment, I understand the pension credit comparison makes the margin a little bit cloudy, but with the improving comps there, at what point should we start to see an improvement in operating margins out of that segment, especially when considering probably what the chemical and industrial businesses have done to margins there?

I think in the fourth quarter, we believe that the operating profit will be -- the margin will be up slightly in the fourth quarter, and in the first quarter, I think we will be out of the comparison on the pension credit and you'll see some improvement in the margins in the Stores group.

Lastly, within the Chemical and the Industrial and the Product Finish business, you talked about Chemical being flat in the third quarter. Can you just remind us what the comparisons were in that business in the first half? And then why it seems like your still a little bit cautious about where that business goes from here?

The comparisons for the first half of the year were negative there, Eric. Again, this is the manufacturing arm of our country, and as that has been soft, we have not been selling products into that. I think our cautiousness is that we have seen so many quarters of softness there that we are just not ready on a one quarter flattening out to predict things are getting stronger.

Okay. Very good. Thank you.

John Roberts.

Am I correct now in doing the math that you're going to add 22 -- or about 22 new stores -- in the fourth quarter?

That is correct.

And so that's up from 13 in the third quarter. And you haven't added any stores from acquisition in some time. Am I correct in perceiving industrywide the acquisition activity has dropped down relatively low for several quarters now? And do you have any thoughts on when that might pick up again?

I think we could see the activity picked up at the beginning of the year, and so, I think there is still interest out there. And as you know, many times it takes time for these transactions to work their way through the pipeline.

(technical difficulty) visible right now that we might see in the next quarter or so?

I really -- acquisitions are such a sensitive area, I don't want to comment prospectively on any acquisitions.

Okay. I will get back in the queue, but good quarter.

Bob Goldberg.

Good morning. Chris, but I hear correctly? You talked about bidding activity increasing, a slight pickup there. Was that for professional contractors?

Yes, and specifically the comment was on the industrial side, where large industrial maintenance contractors are again being asked to bid on major infrastructure jobs, to bid on painting bridges and manufacturing facilities. And so that is where we are getting that comment anecdotally from those customers.

Okay. How about on the architectural side?

That's been strong all the way through. We have been commenting on how both the professional architectural and the do-it-yourself side has been strong. We have seen the commercial segment of the architectural business, which has been soft for the last perhaps 18 months, again, just like on the industrial side, pick up in bidding activity as new projects are coming off the drawing board. So we're cautiously optimistic that perhaps that will be a little stronger for us going forward too.

Is that flowing through into your sales of spray equipment that's been picking up recently?

As a matter of fact, it has. It's a good question. We have seen sales of large professionals spray rigs improving year-over-year. And that also is usually an indication of contractors' confidence and a portender of things to come.

That being said, you lowered your CAPEX budget for the year. Is that a timing issue or what is your -- ?

No, I don't think that's a timing issue per se. Sean, you want to comment on this?

If you take a look at it, there's a portion of it that is timing. We're doing some work out at the Midwest plant and so forth that may spill over into the first quarter. But we have taken a look at the projects that are out on the board, and just what is out there, we're continuing to invest in our business. But back to what Chris mentioned before and Conway mentioned before as part of the working capital and the productivity and receivables and specifically inventory, we have been able to hold back some of the projects that we had planned earlier in the year.

Preliminarily, would you plan to spend around depreciation or D&A next year as well?

Yes. I would still use roughly 130 million for next year, until we roll up all of the capital expenditure proposals in our planning process.

Lastly, anything new on the competitive arena in the twist-and-pour space? I understand Masco (ph) has the kill (ph) colors line that's now twist-and-pour this year.

That's the only one we have seen on shelves so far.

I understand that's doing fairly well at Wal-Mart?

We would not be prepared to comment on that.

They would have to comment on that.

Thanks so much.

Jeffrey Zekauskas.

This is Silke Kueck for Jeff Zekauskas.

I have two quick questions. On the Automotive side, how has the OEM side of the business done versus the refinishers business? Then, on the (technical difficulty) residing wood care business, if I remember right, I think last quarter that business grew roughly 25 percent. Did it grow at a comparable rate this quarter?

What was the last part of your question on wood care?

I think that the wood care business last quarter grew something like in the 20 percent range, maybe. Is it comparable this quarter?

I don't think we ever commented on what the wood care business grew at last year. But it was growing well. But actually, all three divisions in the Consumer Segment did well this quarter.

Okay. Thank you.

Commenting on your automotive question, as you know, the OEM portion of that business for us is significantly smaller than the refinish, and both of those performed pretty much similar.

Okay. Thanks very much.

Barbara Allen.

Good morning. Conway, I was wondering, am I correct in understanding that there have not been any more cases -- any new cases filed since late last year?

Yes, that is correct. The last cases that were filed were some cases filed in Mississippi to get under the court reform deadline of December 31st, 2002. But this year, there have not been any new cases filed.

I was encouraged in reading about your proactive approach with the Attorneys General -- Attorney Generals -- whatever the correct plural is. Could you update us on the progress of that and how that is working?

I'm going to ask Bob Wells to answer that. Bob has been very active in this program for our Company.

Yes, it is an agreement that was brokered by the NPCA with attorneys general of, I believe, 46 states. It is basically an agreement by the industry to help in an effort to educate consumers on the potential risks of surface preparation in older homes when they are standing or generating dust in homes where lead may be present, to protect themselves with proper respiratory equipment, to do proper cleanup. And Sherwin-Williams and other members of the NPCA are taking the lead on providing educational material through stores to help consumers protect themselves under those circumstances.

It sounds like it's been successful, with 46 attorneys general.

We been very pleased with the response we've seen from across the country.

Has the Rhode Island Attorney General joined?

No.

Lastly, I wondered if you could give us an update on the Ace hardware account and how the rollout will work. This sounds like a nice coup for your Pratt and Lambert line.

Ace currently has around 5000 dealers across the United States that purchase products through their 15 service centers. We rolled this program out last week at their fall show in Atlanta, and a significant number of those dealers were at that show, being exposed to the program for the first time. The program is in their warehouses and ready to go. And the way that that process works is those dealers will place those orders individually, a license to hunt and to sell each and every one of them individually, and will roll those out. We had a fantastic show, we were very pleased with Ace's presentation of the program and the response we got from the dealers. And typically what we have (technical difficulty) process is that orders get placed now for shipment in the spring, as you would expect -- this is not the beginning of the paint season. So we were at or above our expectations in terms of conversions and we will begin to see those orders roll into the first quarter of next year.

Are they any incremental costs that you have incurred as a result of putting these into those 15 warehouses and so forth? (indiscernible) any significance?.

No, I would not say there's any incremental cost. As twist-and-pours continue to become a more important program in our Company, (technical difficulty) expenditure our plants to bring the manufacturing equipment up to speed to handle this innovative package. But all of that has been done with an excellent turn, as we have seen continuing volume going through those lines. Other than that, I would not say there's been any additional cost that doesn't have a return to it.

Okay. Darn, I just forgot what I was going to ask you.

Well, we will be here.

I will get back in queue if I remember what it was. Thank you.

Joseph Sroka.

Good morning. Conway, if you -- 50 net new stores by the end of the year, that probably puts you up right around 2 percent or a tick under 2 percent. Is that sort of a sustainable growth rate for the out years, or would you look to speed it up or slow that down?

You're right, Joe. That will put us under 3 percent, which, as you know in the past, we have commented is a sustainable growth rate for us. This is the lowest net new store count we've had probably in the last three or four years, and I think it is just the way that real estate deals go. We will have years where we will be above 3 percent, years where we'll be below 3 percent. So, our expectation would be to remain on track to hit the 3000 stores by the end of the decade, and to get there by opening stores at about a 3 percent pace, which should give us plenty of room to get there in time.

Anecdotally, as you have reset the Paint Stores, have you seen any greater shift where you have gained more DIY customers relative to professional customers?

You're talking specifically about the refresh program that we have commented on?

Yes.

Yes, I think that we have not seen a significant shift in the mix in these stores nor are we trying to accomplish that with this reset. It just has been providing a cleaner, crisper better shopping environment for all of our customers, and it's just something that needed to be done.

I think our do-it-yourself sales through the stores have been strong, and that may be a contributing factor of making it an attractive place for a DIY’er to shop.

Sounds good. Thank you.

Greg Nejmeh.

Good morning. This is Greg Nejmeh. I just wanted to question you a little bit about the industrial recovery that you're beginning to see. Two questions, really. Number one, is it a function of the fact that the comps are so weak, and I guess perhaps one way of measuring that is if you were to index your industrial activity today vis-a-vis what it would been like a couple of years back, what would that index of activity look like? Second, I know you've done a lot of cost-cutting and asset optimization and rationalization within those businesses. Can you give us a flavor for what kind of leverage you might experience in some of those channels if we begin to see a more meaningful recovery?

Sure. I think that is really an interesting way to look at it. On the industrial maintenance, let's start with that. I think you're right that what we are seeing is a favorable comparison to a low watermark here over the last three or four years. If we were to use your index model of three or four years ago being 100, we probably dropped down into the lower 90s and we're back up into the mid to high 90s. So we still have room to grow; we're just coming off an unofficially low base. Not having looked at it exactly the way you presented it, that kind of gets you close to where I think it is at. Does that help?

Yes.

Okay, good. On the cost cutting question, Sean, you may want to comment on that.

Could you repeat that question again? I'm sorry.

I guess with the reduced level of activity that you have experienced in those channels in the last couple of years, you have obviously brought your cost structure down to account for the lower level of activity. What kind of leverage might exist if that index begins to approach or for that matter rises above 100?

I think that in the short period of time, the leverage would allow us to have some nice flowthrough. I think that some of things that we have done basically to get that cost down we'd end up investing -- push back some investments and so forth, and end up doing investments fairly quickly. So, I think in the short-term (technical difficulty), the margins would improve.

When you talk about the cost-cutting we've done, we service that business through our stores' network, as you know. We have not closed these stores. We have not taken sales reps or corrosion engineers or the things that are important to service out of the Company. As we often comment on, we are working capital intensive Company. We use that to flex up or down. So, it is not like we have cut aggressively there and need to reinvest. I think the infrastructure is in place. When it comes back up, we're ready to go right now and to start to capitalize on that.

So that would really help drop part of the sales to the bottom line.

Right. Okay. Thanks.

Dan Vescano (ph).

My question has been answered. Thanks.

Jack Cassell.

Hi, folks. It's been a good quarter. Just a couple of questions for you guys. First of all, could you talk about the credit quality of the credit you extend in the paint stores to paint contractors? And, secondly, if you could comment on changes on capacity utilization in the U.S. paint industry? Any plants closed or opened by yourselves or by competitors? Thanks.

I'll ask Sean to comment on the credit quality.

If you take a look at our receivable performance, I think we have -- overall, our quality -- we do not take a look -- a lot of our customers do not have a S&P rating or a Moody's rating, so we take a look at it, without calling (ph) a AAA, I would say that in general, we are the same quality as our competitors. I think that if you take a look at some of these small customers that we have, our bad debt as a percent of sales has been below 5/10 a percent of sales -- of charge sales. So we have had (indiscernible) performance in bad debt.

Our past due is looking very good. But as far as a rating on the product quality, I would say that it is sort of a bell-shaped curve. We have some people that are very high and some that are very low, and you're always trying to move that average up. But when you take a look at it, I think it is hard to answer, but I think our quality is -- I would tell you this, I think our credit quality is basically on par with what it has been for the last five to ten years.

Turning to your question on industry capacity, there may have been some decreases. It is difficult to tell, but in actual plant locations in architectural coatings, there may have been some plants shut down with our acquisition of Mautz. That plant was shut down, though I'm not aware of any widespread shutting down of architectural coatings. I think because of various acquisition activity, there has been a number of industrial coatings, chemical coatings plants that have been shut down, and then we have also done some consolidation in that area.

Okay. Thanks a lot.

(OPERATOR INSTRUCTIONS) John Roberts.

Thanks, just some follow-ups here. Did you say that the pension credit will be stable after the next quarter?

Yes. When you take a look at it in the calendar year 2002, we received a $24 million pension credit. This year we are not receiving that credit, and next year I don't see -- the pension credit again will be flat, and so when you take a look at that, that is what I mean, the comparison (indiscernible).

Year-over-year will be flat.

Will be flat.

Most companies are lowering their discount rate and also lowering their plant asset rate, at least several conference calls that I've listened to this quarter. Does your pension end September 30th and (indiscernible) assumptions for next year?

Ours is 12-31. We are looking at it right now. Last year we did reduce ours from -- our long-term from 8.5 to 8, and we will continue to evaluate that, but I think at 8 percent, we are lower than --.

And that's part of the discount rate too.

Right, we took the discount rate from 7.25 to 6.55. So when you take a look at those two factors versus the long-term results, I think some of them are higher than the 8 percent that we're after.

We got those down last year, John, and we will continue to be very conservative there.

So because you've already been conservative, you're not going to maybe face some of the adjustments others might be facing next year?

I think we faced it this year.

We've got it behind us.

Secondly, did you say the Eastern region was the weakest in the Paint Stores Segment?

Well, what we did was rank the -- relative to the other divisions, it was fourth.

And wouldn't that one, though, have had the better sort of catch-up effect from the weather that impacted the second quarter, that they might have had some demand that slid into the third quarter that would have made it --?

Well, you know what, there was whether all over the United States. This is an Eastern crowd we're talking to on the phone today, but everybody had those same kind of scenarios. I think some of the manufacturing slowdown in our country has hit the Eastern part of the country harder. In that segment we have all those businesses, architectural, investor, manufacturing, product finishes, etc. So some of that is lagging out there for us.

Lastly, you did not really comment on raw materials. Is it fair to say they were flat year-over-year or were they up modestly and just offset by modest pricing?

Well, as you know, we only really comment on raw materials from an industry point of view. We have found them reasonably not nearly as volatile as they were in the first half of 2003. We expect for the industry on an annualized year-over-year raw material price increase to be in the 2 to 4 percent range. I think -- we would anticipate it would probably continue at this due to the higher cost of energy with crude oil in a range of $30 a barrel and natural gas around $5 a million BTUs, and we don't see that decreasing. So we think this pressure kind of on that range will remain in the industry throughout the balance of this year and into 2004.

At that relative level, could you offset all of that with formulation, or do you need some price?

Well, we really -- we continue to develop and implement programs that would lower our raw material cost through the implementation of alternate lower-cost technologies. We optimize our manufacturing production capabilities, and then we also do selective price increases. So I think when you look at it on just a very average typical gallon of paint, if it is roughly 50 percent raw material cost and if the industry is going up 2 to 4 percent everything else being equal, at the higher end of that range you would need a 2 percent price increase. So we believe with all of these other factors, we can certainly manage the selective price increases and these productivity enhancements.

Thank you.

Barbara Allen.

Thanks. My question was on the raw materials cost, but I also wanted to check with you; the last time I think I looked, your pension fund was some $200 million overvalued and overfunded.

That's correct.

Not overvalued -- overfunded.

About 250 million.

Oh, it's 250. So that really also should help in terms of pension credits or so forth next year.

We have been overfunded for numerous years. I don't know the exact number, but what happened is when the performance of those assets in the market were below the long-term expected retainer, what happens is they create a debit on your balance sheet that you amortize over a 10-year period. That is the way pension accounting works. Over the last few years, we had an 8.5 percent long-term expected return. Our actual returns were negative. So when you take a look at additional -- that's what caused the credit and the reduction in the credit, because we have to amortize that credit. But what this does do is keep us from putting cash into our pension fund. So when you take a look at it, there is no cash expense.

Okay. Thank you very much.

Jason Putman.

Good morning. Most of my questions have been answered, but could you just give us an update on China and how things are proceeding there?

Sure, Jason. As you know, we have opened our first chemical coatings or product finishes facility in Dongguan province. We are using that to service the growing wood and plastic markets over there. The products that we're selling through that facility are being manufactured in the United States and shipped over there for further blending and coloring and tinting at that location. In the first quarter of next year, we should have our manufacturing facility which is outside of Shanghai opened and operating, which will be able to service that facility as well as participating in the growing markets over there for us. So we are just in our infancy in getting started. We have been very pleased with the ramp-up of our business and the response that we're getting from our customers over there.

Also, the product that is being manufactured in China, once the new plant comes online, it's going to be entirely sold in China? Nothing is going to be shipped back to the U.S. for sale?

That's correct.

Thanks.

Alexander Mitchell.

The question was also about raw material. Did I understand you saying that basically it is a wash, the raw materials versus the price increases over the course of the year?

Well, I think what Conway said was that over time through productivity improvements and some selective price increases, what is a wash is the impact of raw materials in our margin performance.

Alexander, I think the other thing in terms of not only us but all of our competitors are essentially buying from the same suppliers, and so when the suppliers receive these increases in their feedstock, that basically all of our competitors are faced with the same raw material cost pressures. So, in my opinion, after roughly nine months or so, this usually works its way through the marketplace.

Okay. Do you want to take a stab at all at next year where you see raw materials considering, I guess, the first half? There was a dramatic spike last year -- or this year, rather.

Well, I think right now, because we are definitely not forecasters of what will happen in the energy market. But our sense is that crude oil and natural gas will remain trading in their current ranges. And so we think that that will maintain the same kind of raw material pricing pressure next year as we are seeing this year. But I think it should be stable in that regard, but with upward pressure in the low single digits for the industry.

Okay. Thank you very much.

That concludes the question-and-answer session. Mr. Ivy, I will turn it back over to you.

Thank you all very much for joining us. As you all know, Bob Wells and I will be available. Should any of you wish to call and have additional questions, we will be pleased to respond. So thank you very much for joining us.

That concludes today's teleconference. Thank you for joining us.