宣偉 (SHW) 2005 Q2 法說會逐字稿

Greetings, and welcome to the Sherwin-Williams Company's second quarter 2005 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, Senior Vice President 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. Gentlemen, you may begin.

Thank you, Megan. Good morning, everyone. Thank you for joining us today for the review of our second quarter 2005 results and our expectations for the remainder of the 2005 year. This conference call is being Webcast simultaneously in listen-only mode by Vcall via 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 Monday, August 1, 2005 at 5 p.m. ET. Before proceeding, I'd like to remind you that during this conference call we will make certain forward-looking statements as defined under the U.S. Federal Securities Laws with respect to sales, earnings, and other matters. Any forward-looking statements 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. A full declaration regarding forward-looking statements is provided in our earnings release transmitted earlier this morning. After the review of our results, we will open this session to questions.

Summarizing the Company's overall performance in the second quarter of 2005 versus second quarter 2004, consolidated net sales increased 21.5% to $1.97 billion. This result reflects strong sales performance by stores opened more than 12 months, acquisitions, and improved Automotive and International segment sales. Consolidated gross margin for the quarter decreased to 42.6% from 44.6% for the same period last year. This decrease resulted primarily from raw material cost increases, most notably TiO2, steel containers, acetones and various solvents that were partially offset by price increases and improved manufacturing absorption. SG&A as a percent of sales decreased to 30.2% from 31.8% in the same period last year reflecting the combined impact of strong sales growth and tight expense control. Interest expense for the quarter increased $4.2 million to $13.6 million as a result of short-term borrowings primarily to fund acquisitions. Other expense net increased by $8.9 million due primarily to an increase in provisions for environmental remediation activities. Income before taxes increased 24.4 million or 12.5% to $219.6 million. Net income increased 21.2% to $153.2 million from $126.4 million in the second quarter of 2004. Diluted net income per common share for the quarter increased 24.1% to $1.08 per share, compared to $0.87 per share in 2004. The increase of $0.21 in the quarter resulted from $0.10 per share improvement in operating performance, $0.06 per share contribution from acquisitions, $0.08 per share from the lower effective tax rate resulting primarily from favorable tax rulings, and $0.03 per share from a reduction in the average number of diluted shares outstanding. These increases were partially offset by a reduction of $0.06 per share due to increased environmental provisions.

In reviewing our performance by segment for second quarter 2005 versus second quarter 2004, I will start with our Paint Stores segment. Sales in our Paint Stores segment increased 26.4% to $1.3 billion. This was due primarily to strong gains in architectural paint sales to contractors, increased sales to do-it-yourself customers, and to stronger industrial maintenance and product finishes sales compared to second quarter last year. Regionally, our Southeastern division led the sales performance followed by Southwestern division, Midwestern division, and Eastern division. Our Chemical Coatings division achieved strong sales growth during the quarter. Comparable store sales or net sales from stores opened more than 12 calendar months increased 14.5% during the second quarter. This figure includes sales of industrial maintenance coatings and product finishes, both of which had favorable comparisons. Operating profit increased 30.3% to 187.4 million from 143.8 million in the second quarter 2004. Operating margin for the quarter improved to 14.3% from 13.9% last year. This improvement resulted from strong sales volume growth, effective SG&A expense control, and higher selling prices that partially offset higher raw material costs. The operations of Duron Incorporated accounted for 2.6% of the segment's operating profit in the quarter. Paint Stores ended the quarter with 3,011 stores in operation in the U.S., Canada, Mexico, Puerto Rico, and the Virgin Islands.

Turning now to the Consumer segment for the second quarter of 2005 versus second quarter 2004, sales increased 11.9% to 14 -- $415.9 million. Acquisitions completed since the second quarter of 2004 accounted for approximately 9.7% of the second quarter 2005 net sales increase. During the second quarter sales increases resulting from new product introductions, paint sales volume growth, and higher selling prices more than offset the elimination of a paint program by one customer and sluggish sales at some of our retail accounts. Operating profit for the Consumer segment declined $5 million to 65 million, compared to second quarter 2004. Acquisitions added $8.5 million to the segment's operating profit. Continuing significant raw material costs increases in the quarter were only partially offset by higher selling prices, tight expense control, and favorable manufacturing absorption related to the increase buy and through the Paint Stores segment.

For our Automotive Finishes segment, sales for the second quarter 2005 increased 9.2% to 143.6 million from 131.5 million in the second quarter of 2004. This increase was primarily due to favorable currency exchange rates that added 3.1% to net sales in the quarter and to higher selling prices. Operating profit for this segment improved 7.6% to $17.5 million, compared to 16.3 million in the second quarter of 2004. The increase in net sales and tight expense control only partially offset the negative impact of significant raw material cost increases on operating margins. In terms of our International Coating segment in the second quarter of 2005, this segment posted a 22.5% increase in net sales to $93.3 million from 76.1 million in the second quarter of 2004. Favorable currency exchange fluctuations accounted for a significant portion of the sales increase in U.S. dollars. Sales in local currencies increased 9.7% over second quarter 2004 as a result of volume gains in South America and the higher selling prices. Second quarter operating profit for the segment in U.S. dollars increased to 3.3 million from $1.3 million a year ago. This was due primarily to increased sales, favorable currency exchange rates, and manufacturing efficiencies related to increased volume. These factors were partially offset by significant increases in the cost of many raw materials.

I would now like to -- you will find more balance sheet information on our website under www.sherwin.com. Our working capital ratio, accounts receivable, plus inventories less payables to sales came in at 16.6% versus 13.2% for the second quarter of 2004. And this is based on 12-month sales and average working capital. This increase was due primarily to the acquisitions completed last year. Our total debt on June 30, 2005 was $901.3 million. Short-term borrowings of approximately 400 million remained open at June 30th, most of which was used to finance recent acquisitions and seasonal working capital needs. Total borrowings to capitalization were 34.5% at the end of the quarter versus 25.4% at the end of the second quarter in 2004. Long-term debt-to-capitalization was 22.6% at the end of the second quarter this year, compared to 10.6% last year. We expect our total debt-to-capitalization ratio will be approximately 25% at the end of 2005. In the second quarter of 2005, the Company purchased just over 1 million shares of its common stock in the open market. At June 30th the Company had authorization to purchase approximately 6.7 million shares of its common stock. We expect to continue from time to time our opportunistic purchases of company stock for treasury since we continue to believe our stock is a good value.

In second quarter 2005, we spent $39.2 million on capital expenditure, depreciation expense was 29.4 million, and amortization expense was $6.1 million. For the full year 2005, we expect capital expenditures will be approximately $150 million. The predominant share of the incremental increase in capital expenditures relative to last year will go towards expanding our manufacturing capacity, including the construction of a new emulsion plant in the Western United States. In addition, the increase in capital expenditures reflect the completion of a rollout of automated color-matching equipment in our stores, additional point-of-sale devices, and investment in other systems. Depreciation for the year will be around 120 million versus $109 million in 2004. And amortization will be $23 million versus 16.6 million in 2004.

I would like now to give you a brief update on the status of our lead litigation. In July the Supreme Court of Wisconsin ruled on the summary judgment decisions previously issued by the Trial Court and the Appellate Court in the defendant's favor concerning a personal injury suit against former lead pigment manufacturers. The Supreme Court upheld both lower courts' findings on two issues. One, that there was not sufficient grounds to claim a civil conspiracy, and the other was that the collective liability theory of enterprise liability could not be applied. The Supreme Court overturned the Trial and Appellate Courts' ruling dismissing the applicability of a risked contribution theory to lead pigment. This theory, should the defendants be found at fault, would apportion liability according to market share. The Wisconsin Supreme Court's risk apportionment theory, in our view, is an aberrational treatment of market share liability unrecognized in any other state. It is presently unclear how the theory will be applied to apportion liability should any exist among the defendants. The Supreme Court declined to rule on any of the Constitutional issues as to due process at this time reserving these issues for future review, should the defendants raise them again.

In Mississippi, an adult painter's suit scheduled for trial in Federal Court in June of 2005 was dismissed by the Court. As a reminder, earlier this year 21 adult painter plaintiffs in other suits filed dismissal notices in various Mississippi State Courts in cases filed against Sherwin-Williams. The remaining adult and children cases in Mississippi are in various stages of discovery and motion practice. As we have mentioned in the past, a number of cases have been dismissed by the Trial Courts and are under appeal to the higher State Courts. These cases include jurisdictions of New Jersey, Wisconsin, and California. A motion for dismissal is currently before the Trial Court in St. Louis. It is possible that decisions on the dismissals of these cases could be rendered before the end of this year.

In Rhode Island, Dupont, one of the defendants in the Rhode Island case, reached an agreement with the Attorney General for Dupont to be dropped from the case after agreeing to donate $12.5 million to various charities. Dupont's decision in this regard does not impact the defense of other defendants nor influence the conduct of the forthcoming trial. The retrial of the State's case against former lead pigment manufacturers was scheduled to start on September 7, 2005. The Judge has now set jury selection to begin on September 7th and for the trial to start after the jury has been selected. As a reminder, to date we've had less than 100 lead litigation cases filed since 1987, excluding the most recent cases over 85% have been dismissed and none have ever been settled. Only one, Rhode Island, has ever come to trial. This completes my review of our results for the second quarter of 2005. Now, I would like to turn this session over to Chris Connor, who will make some general comments and highlight our expectations for the third and fourth quarter and full year. We will then open the call to questions. Chris?

Thanks, Conway. And good morning, everybody. And thanks to all of you for taking time out to join us. Now with the solid first half of 2005 behind us and in the books, we feel very good about our prospects for the full year. Although the comparisons are going to get a little tougher in the second half, particularly in the fourth quarter when we annualize two large acquisitions, we're confident that we can sustain the strong operating momentum we've established over the balance of the year. Much of the momentum in the first half came from our Paint Stores segment. A combination of 25% sales increase including a 12.7% comp store increase year-to-date with a 90 basis point improvement on operating margin, clearly illustrates, we think, the advantages of our controlled distribution strategy in this environment. During this second quarter we opened 21 net new stores, compared to 13 in the second quarter of last year, and no stores were closed, this brings our year-to-date total to 28 net new stores and this rate is going to accelerate in the second half and will keep us on track to open in the range of 80 to 90 net new stores during calendar year 2005.

High raw material costs in the second quarter kept pressure on our consolidated gross margins as Conway reviewed with you, and we expect this to continue over the balance of the year. For the full year 2005 we expect our consolidated gross margin to decline somewhat compared to 2004; however, through our company-wide efforts to control expenses and maximize our productivity, we expect our pretax return on sales to improve slightly on a year-over-year basis. The upward pressure on raw material costs continue, and this is driven by the rising cost of oil, natural gas, and global raw material supply and demand. And as you all well know, the cost of oil has been extremely volatile this year. It's an ongoing concern to us and it could further impact raw material pricing if oil remains in the range of $60 per barrel for a prolonged period of time. On the other hand, however, in the global supply demand picture has improved somewhat. Demand in China and other areas of the world has eased and availability has improved as several new petrochemical complexes have started to produce product. This has had some stabilizing effect on the pricing of certain raw materials.

Based upon the data that we can see today, we anticipate that the paint and coatings industry will continue to experience high raw material costs throughout 2005. Our previous industry forecasts of year-over-year raw material cost increase in the range of 10 to 15% continues to appear to be right on target. Some of these raw material costs do appear to be stabilizing, as I commented earlier, which is positive. But we do not see a full-scale pull back of the large price increases the industry has sustained in the last year. That makes the implications for our Company clear. We must remain diligent in our efforts to fully implement the announced price increases, account by account, and at the same time continue to mitigate these raw material cost increases to every extent possible through manufacturing efficiencies, higher fixed cost absorption, and tight expense control. Most of our remarks today have focused appropriately on sales and income, and I'd like to take a few moments to comment on the progress we continue to make on our balance sheet.

During the second quarter we used cash to further strengthen our financial position and bolster our return to shareholders. We retired approximately $90 million of debt during the quarter, invested almost $40 million in capital expenditures, a portion of which went towards the ongoing construction of a new West Coast emulsion plant, as Conway mentioned. And we paid more than $28 million in cash dividends, as well as purchased 1 million shares of our stock on the open market for treasury. This brings our total treasury stock purchase for the year to 3.7 million shares. We will continue to use cash that we generate from operations to strengthen our Company and reward our shareholders. Yesterday we had the pleasure of welcoming David Hodnik, retired President and Chief Executive Officer of Ace Hardware Corporation to the Sherwin-Williams Board of Directors. Dave brings a wealth of experience in the areas of financial management and home improvement and product retailing to the Board. We're very pleased to have Dave and look forward to his significant contributions to our Company.

I'll conclude my remarks this morning by updating our outlook for the third and fourth quarters and full-year 2005. We expect third quarter sales growth in the mid-teens over third quarter 2004. With sales at this level we expect diluted net income per common share to be in the range of $1.06 to $1.10 per share, compared to $0.92 per share in the third quarter of last year. We expect net sales in the fourth quarter to increase in the more moderate high single-digit range over last year as we annualized the Duron and Paint Sundry brands acquisitions. Although, we anticipate fourth quarter profit before taxes will be up year-over-year, diluted earnings per share will be down slightly from last year's $0.57 per share due to a significantly higher effective tax rate for the quarter compared to fourth quarter of 2004. Our effective tax rate for the full year, however, will be slightly below the annual rate for 2004. For the year, then, we expect consolidated net sales to be up in the mid to high teens over 2004. With annual sales at that level, we are once again revising our annual estimate upwards, and not only participate diluted net income per common share for the year to be in the range of $3.20 to $3.30 per share, compared to $2.72 per share reported in 2004. Again, thanks to all of you for joining us, and I would be happy to open the floor for questions.

Thank you, sir. Ladies and gentlemen, at this time we will be conducting a question-and-answer session. [OPERATOR INSTRUCTIONS]. Our first question is coming from Eric Bosshard of Midwest Research.

Good morning.

Good morning, Eric.

A couple questions. First of all, you began the year with guidance of 3 to 3.10 and 3 became 3.10 to 3.20, now it becomes 3.20 to 3.30, which is a nice problem to have. But can you give us a sense of what's taken place in the first 180 days of the year that has resulted in earnings being so materially better than you thought?

Clearly, Eric, it's been the sales performance of the Company. Comp store sales growth 14% for the quarter, 12% year-to-date. It's accelerating. And as we've seen that opportunity to increase sales and bring that to the bottom line and we've revised our guidance.

Within the better-than-expected sales performance, how much of that do you believe is the market and how much of that do you believe is you gaining share and how much of that is better success than you might have thought with price and/or product mix?

I think it would be weighted toward the latter two points. I think that we probably -- we haven't seen the industry's data, but we probably are gaining share. And I think the evidence in some of our segments, not all of our segments, indicate that we are getting price increases.

Secondly, in terms of the price contribution, what you realized in the second quarter relative to the first quarter, can you give us a sense of -- are you seeing more contribution from price as these things stage in, or is it comparable? Should we expect the second half to be similar to what we realized in the second quarter?

Eric, when we were asked the question in the first quarter -- how our implementation of our price increases were going, we basically said that because of previous customer commitments our price increases put into the effect over time, and as these commitments continue to expire. In the first quarter we had said that we are approximately 40 to 60% implemented in our price increases. I would say in the second quarter we are now 55 to 80% implemented.

So there still should be -- so should we get the balance of that, Sean, then in the third quarter?

Well, we continue -- and this goes back to the question you asked earlier about the price. We're working on it. We still have to work on some timing, but over the course of the whole Company, we believe we will get some in the third quarter. But probably --. [multiple speakers].

Not all the way up to 100%, Eric.

Okay. And then my last question from a momentum standpoint you gave us some sense from a regional standpoint the behavior in the quarter. But from a momentum standpoint with these strong numbers in the quarter, was it similar momentum through the third quarter as we've gotten into early July? Has the momentum sustained give us -- obviously you have got pretty bullish sales guidance for 3Q. But help us understand a little bit about how the momentum of the sales performance --? [multiple speakers].

Eric, it's been very consistent. We were strong on a double-digit every month in the quarter and the third quarter starting out the same.

Wonderful. Thank you, Chris.

Our next question is coming from Armando Lopez of Morgan Stanley.

Yes, good morning, guys. A couple of quick questions. I guess first, can you just maybe expand a little bit more on the environmental accrual that you guys incurred in the quarter?

When you take a look at the environmental accrual, we've always maintained our environmental accruals to the proper level. Over the last few years, we have a professional staff that continually works on these, and these are projects and situations that are not current. They've been resident in the Company for a long time. When you take a look at the last few years with the -- usually in the fourth quarter you usually see an environmental reserve increase. And that's due to -- usually once a year we have to sit down with the professional staff, go through to see where they were, where they were on certain projects, to see and make sure that our accruals were correct.

With Sarbanes-Oxley we have changed that procedure. We basically take a look at it on a quarterly basis, and because of that, there's some activities that have been going on in the second quarter that have led us to believe that we can now adjust our accruals accurately in the second quarter. When we take a look at the full year, the full year cash outlays for environmental will be very consistent with the last few years. We believe our total expense will be up slightly for the full year, but we just believe that we've recognized it in the second quarter.

Okay. Great. And then I was wondering, could you guys give us maybe a little bit of update in terms of Ready-To-Roll, how that's proceeding relative to your expectations and how to think about that going forward?

Yes, we -- continued to be very confident and excited about the performance of Ready-To-Roll. It's available now at quite a number of retailers, Menard's, Fred Meyer, Value Home Centers, Chase Pitkin, Meyer Stores, Sears Hardware, Sutherlands, and Orchard Supply. So the rollout continues. Consumer feedback has been terrific, and we're excited about it. Continuing to participate in Dutch Boy's reinvasion in the market.

Okay. Great. And then one last one. I was just wondering if you could comment maybe on what you guys are seeing from an acquisition pipeline perspective and how you're thinking about that?

That has remained about the same, and I think as you know we continually, actively look at acquisitions and evaluate those. And I would say it's still a very important part of our strategy.

Okay. All right. Great. Thanks guys.

Thank you.

Our next question is coming from Jerry [sic] Zekauskas of JPMorgan.

Hi, good morning.

Good morning, Jeff.

Just a couple of short questions. In the same-stores sales growth, was price a larger contributor than volume or is it vice versa?

Vice versa. Definitely volume.

Definitely volume. Can you talk about your overall gallonage growth in the quarter?

I don't think we want to break that out for various reasons.

Jeff, we've taken a look at the volume price mix for the Company with the acquisition of Paint Sundry brands, the unit volume in total really is not meaningful when you start -- just the impact that that had. In order to make it meaningful we would have to report the volume by product category, which would put certain operating divisions at our Company at a competitive disadvantage in the market. So just for that reason we don't want -- once we start going down this path, we'd have to get to such detail, we really don't want to go down that path.

But specifically to your question on stores, we've talked about the price increases we've announced there year-over-year. And with the comps at 14% for the quarter, you can clearly see the impact to volume there.

Yes, right. And then just lastly in terms of the ruling in Wisconsin, the ruling in Wisconsin plainly was not positive, but it's difficult to know sort of how negative it is. So I guess there are three areas I'd like you to comment on. First, in some of the dissenters' opinions, there was a concern that Wisconsin may be a haven for the filing of many new lead pigment suits. And I was wondering what your impression was there or what you had seen?

Secondly, the ruling in Wisconsin was on a summary judgment, and I'm not an expert at all in these areas, but are summary judgment rulings ever appealed to the U.S. Supreme Court, or that's just not done, that is just cases that have rulings are appealed to the Supreme Court? And thirdly, does the ruling in Wisconsin affect the kind of instructions that a judge would give to a jury in that it seems that the Wisconsin ruling may involve a different standard of proof?

Jeff, in the first -- your first question, would this result in a onslaught of suits in terms of lead pigment in Wisconsin, we don't know. We have to wait and see what impact that would have. I think depending on how the plaintiff's lawyer looks at this ruling it could have even broader aspects even beyond lead pigment. So we just have to wait and see. And we don't know. I think in terms of the summary judgment, I think as I mentioned the Supreme Court failed to rule on the definite due process issues that are constitutional issues, and so those aspects would potentially be appealable to the U.S. Supreme Court. But I don't want to and cannot comment on what the defendants might do in that regard.

I think in terms of your third question of how this ruling may affect standards of proof or basic jury instructions, it really literally is presently unclear of how this theory that the Supreme Court has opined on will really be applied to the apportion of liability, should any exist. And so I would think the ongoing legal process, should this case come to trial, it will be going through a standard trial procedures of discoveries. Also will no doubt result in motions by both plaintiffs and defendants and that. And so I think part of that process there would need to be clarity on what -- how this would be applied. But right now, there is not clarity on how the rule would be applied to apportion liability.

Okay. Thank you very much.

Thank you.

Our next question is coming from Chuck Cerankosky of Key McDonald.

Good morning, everyone

Good morning, Chuck.

In looking at gross margin for the second half of the year -- well, first amount -- you had more gross margin erosion in the second quarter. I wonder if you could comment on that, Sean? And then, Chris, looking at the second half of the year, how do you see gross margin comparing year-over-year in light of implementing further price increases, maybe announcing some more with your Paint Stores or at the dealer level and with the assumption that raw material prices increased 10 to 15%?

Chuck, on your first question, on the gross margin erosion from the first quarter to the second quarter, your 100% right. The gross margin in the second quarter was down 2%. When you take a look at the timing, I think that had to do a lot more with timing and mix than it did pricing. And I think we're -- as we mentioned before, with the price increases more -- higher implemented in the second quarter, you see more of a mix change. And that's why we sort of avoided this whole price volume mix. We do believe that for the full year our gross margins will be down slightly, but I think that when you [indiscernible] the second quarter just with the vein that we did have, and so forth, the margin was close to what we thought we would be -- where we would be at.

And I think looking out for the remainder of the year, Chuck, to Sean's comments gross margins will be slightly down so we don't see a significant trend either direction. Raws are going to stay up, we're going to stay diligent in the marketplace, and they should be right about where they've tracked for the first six months.

Right. So second half gross margin should be in-line with the first half? Is that what you're --?

[multiple speakers] are being slightly below last year's performance. That's correct.

All right. Thank you.

And that's the way we've been managing the business throughout the year.

Great quarter. Thank you.

Thanks.

Our next question is coming from Larry Horan of Janney Montgomery Scott.

Hi, Larry.

Good morning. Drilling down just a little bit further in terms of your comp store sales number and the increase and the comments that you answered Eric's question on market share and price were more the reason. Would price be more important than market share in that regard?

I don't think so.

Okay. Thanks.

Thank you.

Our next question is coming from Barbara Allen of Avondale Partners.

Thank you. And I'd really like to congratulate you, Chris, and your team on such great execution of what is, I think, an extremely good long-term strategy. It's a pleasure to watch you guys at work.

Thank you. [multiple speakers].

I do have a couple of questions. Conway, in the second operating income, your administrative expenses are up almost 50%. Is that the environmental accrual, or is there more to that?

That's the environmental accrual and interest expense primarily in that. I think where we break that apart environmental accrual year-over-year changes around 10 million, and I think the interest expense is another 4 million. So that accounts for most of the change.

Thank you. And, Chris, I wondered if you could expand a little bit on your comment. You said you remain concerned about the sluggish paint sales in the Consumers segment. What's happening? Is this -- your DIY sales I understand improved. Can you give us a little color on what you see?

Sure. As the year has gone on, Barbara, we've talked about the loss of a major account, Canadian Tire, that we've identified with some new businesses coming on. We have seen some as we typically do from time to time inventory adjustments, its various major accounts going up and down, and beyond those type of activities, there's not really anything specific that I would call out. I would note that in an environment where the company is generating 20-plus percent sales gains and 14% comps, sluggish results look pretty good to us three or four years ago. We're talking mid single-digits for the Consumer Segment. So while we're certainly not keeping pace with the rest of the Company, we're not disappointed at all in the performance of this team. They're contributing and adding value here.

Okay. I just -- I didn't know if you were seeing something that was more industrywide that was bothering you.

No. I think that the market continued to do fine.

Okay. Thanks very much.

Our next question is a follow-up question coming from Jeffrey Zekauskas of JPMorgan.

I guess two short questions for Chris. Some people talk about housing bubble, and plainly your store's businesses have been exceptionally strong. Does this lead you to be a little bit more cautious for 2006? And secondly, can you comment on the disparity between the rate of growth and the store's business and the rate of growth in the consumer side?

Regarding the housing bubble, Jeff. This is a topic that we've discussed frequently, because it is a concern to many investors. The comfort we've tried to provide is to point out that 80 to 90% of all architectural coatings are used to maintain and redecorate existing structures with only approximately 10 to 20% of these coatings used on new construction. And inside that 10 to 20, you have new commercial construction, schools, hospitals, office buildings, et cetera, as well as new residential family housing. So if in fact, the housing -- new residential construction market is in a bubble environment and it was going to burst and no houses were going to be built a year from now versus the rate we're at now, the architectural demand may slacken by 5 to 10%.

So we don't look at that as any kind of a concern for the Company. We've been through cycles over the last several decades were housing starts, have a fallen year-over-year, and the Company has managed comp source sales gain, gallon growth, and market share through that cycle. So we don't particularly concern about that. We will be planning for 2006 coming up in the fall this year and, of course, be given guidance to that in our first quarter call next year. Your second question regarding the rate of growth for our stores for our Consumer segment, I think points to the strategy of the Company with controlled distribution and why we continue to invest heavily in opening new stores at a rapid pace, opening new stores about every four days now, and continuing to reach out to that growing professional contractor through that store base. We think that is part of the winning strategy, and clearly the results are showing.

Was the rate of price growth in stores much greater than the rate of price growth in consumer?

Yes. And again, we've talked about the pricing leverage there versus through our other retailing partners. And when Sean gives a range that we're 55 to 80% implemented, that range kind of covers where we're at there.

So when do you think you'll actually be able to cover your raw material costs on the consumer side?

I think, Jeff, we are encouraged. We're seeing some of our retail customers starting to increase their shelf pricing, and so I think that will help the industry implement price increases in these channels.

Well, you know, Conway, I'm encouraged too, but I was wondering when you thought that you might be able to cover the raw material costs.

How about never? [Laughter]. Well, for the year, you know, our -- as Sean mentioned, our gross margin will still be down slightly, and I think if oil stabilizes in this level and I think it depends on what happens on TiO2, which is not driven by the oil prices, I think that would determine when the iterated process might slow down. I think we are seeing improved availability in a lot of materials, but TiO2 has gone up significantly this year with four price increases announced. And we see in the latex polymer manufacturers are still seeking price increases, but I think part of this pressure, other than TiO2 is abating. So if the price of oil and natural gas kind of stabilize on this level, I would think we'd be able to catch up next year, but that's the caveat of what happens to some of these basic food stock inputs.

And Jeff, you probably have seen in the second quarter operating margin in the segment -- Consumer segment was down?

Yes.

We do believe it will be down in the third and fourth quarter.

In the third and fourth. Okay. That's very helpful. Thank you very much.

Thank you.

Our next question is coming from Alex Mitchell of Scopus Asset Management.

Good morning. It's Bob Goldberg sitting in for Alex.

Good morning.

What are your expectations for raw materials sequentially from 2Q to 3Q [audio difficulty] they were flattish?

Well, I think what we have indicated for the industry, we obviously only comment on -- based on the industry. For year-over-year 2005 over 2004 we would expect it to be up between 10 and 15%. And I think in terms of this we would given the volatility that we're seeing in the market, particularly, with the oil prices, it's very difficult to predict raw material costs movement from quarter-to-quarter. So I think the best that we could do to help give you guidance is we think we're still on target in terms of our first quarter estimate that industry raw material costs would be up 10 to 15% year-over-year. And we still feel the industry will -- remains in that range for the second quarter.

And then it would be up that range for the third quarter as well year-over-year?

Year-over-year, yes.

Chris I was wondering -- ?

Yes, we haven't seen -- we haven't -- based on what we're seeing right now, we haven't seen a reason to change what our estimate for the full year-over-year increase would be.

Okay. So you haven't seen any outright declines in raw materials yet?

No. With the demand factors still being relatively strong we haven't seen any declines. And I think though we've seen some softening of demand factors in Asia in that, that's right now improving availability of raw materials. But we don't expect any price declines because of the demand factors.

Chris, I just wanted to ask you about the -- what you're seeing in the contractor market. Obviously, it's very strong. But I just wanted to get a sense as to their backlogs. Are they hiring new painters? How has that changed since the beginning of the year their optimism or lack thereof?

I think their optimism from the beginning of the year has been consistent and steady and to your point the things that we look to in terms of backlog, number of jobs, painters hired, equipment sales all would indicate that they're very confident about a strong second half as well.

Okay. And finally just one question on the tax rate. I apologize if I missed this, but have you given any guidance as to what the tax rate will be in the third and fourth quarter, as obviously the fourth quarter seems like it is going to be the highest tax rate of the year?

Yes. When we take a look at it, we believe the third quarter will be between 31 and 32% and then the fourth quarter will be between 33 and 34%.

Great. Thanks a lot.

And for the year we believe that it will be in the low 30s. Last year for the full year we were at 32. We believe it will be in the -- below that.

And is it too soon to talk about next year?

Yes.

Yes.

Yes, okay. Great. Thank you.

We normally do our planning in the fall and then we indicate our expectations for the 2006 year in our year-end conference call.

Thanks a lot.

Thank you.

Our next question is a follow-up question coming from Chuck Cerankosky of Key McDonald.

Sean, I have got another question for you. Looking at that increase in the provision year-over-year for environmental, how much of that is cash?

Basically, 5% of it is cash. Probably 95% was for the -- was accruals.

We wouldn't expect to see our cash outlays for environmental changing that dramatically from what they have been.

Okay. And, Sean, could you reiterate that guidance for the third and fourth quarter tax rates, please? I don't think I got it down.

Sure, Chuck. In the third quarter we believe that the tax rate will be between 31 and 32%. And in the fourth quarter 33 to 34%. And if you remember in the fourth quarter last year we were at 17.8%.

Right. Okay. Thank you.

And for the year we'll be below the 32% we were last year; slightly below.

Okay.

Gentlemen, it appears there are no further questions in the queue at this time. Do you have any closing comments?

Yes. Thank you all for joining us today. And as you know Bob Wells and I will be available to answer your questions individually. So thank you for joining us. And for those of you who have additional questions, we look forward to speaking with you. Thank you very much.

Thank you for participating in today's teleconference. You may disconnect your lines at this time, and have a wonderful day.