宣偉 (SHW) 2006 Q3 法說會逐字稿

Good morning, thank you for joining the Sherwin-Williams Company's review of the third quarter 2006 financial results and expectations for the fourth quarter and full year. With us on today's call are Chris Connor, Chairman, President and CEO; Sean Hennessy, Senior Vice President of Finance & CFO; John Ault, Vice-President, Corporate Controller; and Bob Wells, Vice President Corporate Communications. [OPERATOR INSTRUCTIONS]

This conference call will include certain forward-looking statements as defined under 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 the Company's earnings release transmitted earlier this morning. After the Company's opening remarks, we will open the session to questions. I will now turn the call over to Bob Wells.

Thanks. 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."

Summarizing overall Company performance for the third quarter 2006 versus third quarter 2005, consolidated net sales increased 7.1% to $2.1 billion reflecting continued growth in comparable store sales in our paint stores group and strong sales in our global group. Consolidated gross profit increased $96 million for the quarter to $935.8 million. Gross margin increased to 44.2% of sales from 42.5% in the third quarter of last year, due primarily to the implementation of price increases during the past four quarters.

Selling, general and administrative expenses increased slightly to 30.7% of sales in the third quarter this year from 30.5% last year. Interest expense for the quarter increased by $4.3 million to $16.4 million due to an increase in short-term borrowings. However, this increase was more than offset by an increase of $4.8 million in income from investments made to maintain financial flexibility. Our affective income tax rate for the third quarter 2006 increased to 35.3% from 30.6% in the third quarter of 2005.

Consolidated net income for the quarter increased by $27.5 million or 18.1% to $179.1 million from $151.6 million in the third quarter of 2005. Net income as a percent of sales improved to 8.5% in the third quarter this year from 7.7% last year due primarily to improved operations. Diluted net income per common share for the quarter increased 21.5% to $1.30 per share, compared to $1.07 per share in the third quarter of 2005.

Looking at our results by segment. Sales for our paint stores group in third quarter 2006 increased 9.5% to $1.3 billion. Comparable store sales, sales by stores opened more than 12 calendar months grew 7.2%. Sales growth for the group was driven primarily by stronger architectural paint sales to contractors and gains in industrial maintenance coating sales that more than offset slowing sales to do-it-yourself customers.

Regionally in the third quarter 2006, our Southwestern division led the sales performance, followed by Southeastern division, Eastern division and Midwestern division. Segment profit for the group increased 27.1% to $226.7 million for the quarter. Segment profit margin increased to 16.8% of sales from 14.5% due primarily to increased paint sales volume, effective SG&A expense control and higher selling prices on paint and nonpaint product lines.

In the consumer group for third quarter 2006, sales decreased 1.5% to $355 million. These sales declines were due to a combination of inventory reductions at some major retail accounts, slowing do-it-yourself traffic, and the elimination of a paint program with a large retail customer. Segment profit for the consumer group increased 11.4% in the quarter to $60.3 million. Segment profit as a percent of external sales improved to 17% from 15% in the third quarter last year as a result of selling price increases, tight spending control and favorable manufacturing absorption from volume increases through the paint stores group that combined to offset continuing raw material cost increases.

Turning to our global group for the third quarter of 2006. Sales in U.S. dollars increased 7.4% to $412 million. Sales in local currency grew by 5.6% in the third quarter, due primarily to selling price increases and global growth from all operations worldwide. Segment profit for the global group increased 81.5% to $42.7 million for the quarter and segment profit margin improved to 10.4% of sales from 6.1% last year. This improvement was mostly attributable to increased sales, operating efficiencies related to increased volume and expense control.

Currency exchange had no significant impact on segment profit. Global group's third quarter segment profit last year was negatively impacted by a $7.9 million loss on the disposition of its majority interest in an automotive coatings joint venture in China.

I would like now to comment briefly on some of our balance sheet items. Our working capital ratio, that is accounts receivable, plus inventories less payables to sales, came in at 13.1% in the third quarter 2006 versus 15.1% for the same period last year. This is based on 12 month sales and average working capital.

Our total debt on September 30, 2006, was $783.1 million, including total short-term borrowings of $275.7 million. Our cash balance at September 30, 2006 was $400.4 million, compared to $29.8 million in 2005. Total borrowings to capitalization were 27.5% at the end of the quarter versus 30.8% at the end of the third quarter 2005. Long term debt to capitalization was 19.7% at the end of the third quarter this year, compared to 22.1% last year.

In the third quarter 2006, the Company purchased 1.7 million shares of our common stock in the open market. At September 30, 2006, the Company had authorization to purchase approximately 15.5 million shares of its common stock. We expect to continue ,from time to time, our opportunistic purchase of the Company's stock for Treasury, since we continue to believe our stock is a good value.

In third quarter 2006, we spent $49.9 million on capital expenditures. Depreciation expense was $30.9 million. And amortization expense was $5.6 million. For the full year 2006, capital expenditures will be approximately $160 million. A significant portion of which will go toward expanding our manufacturing capacity, including the new emulsion plant in Nevada. Depreciation will be about $125 million versus $120 million in 2005. And amortization will be $23 million versus $23 million in 2005.

I will conclude this review with a brief update on the status of our lead paint litigation. Following the February 2006 jury verdict in favor of the State in the Rhode Island Lead Pigment Trial, The defendant companies filed numerous motions asking the court to enter a judgment in the defendant's favor or failing that, to order a new trial. In late August, the judge called a hearing to discuss these motions. On August 30 and 31, the judge heard arguments on the State's failure to prove nexus on data withheld by the State and other post-trial motions raised by the defendants.

The judge has indicated no timetable as to when he will render his decision. Should these motions be denied, defendants intend to appeal the case to the Rhode Island Supreme Court. In the City of Milwaukee's Public Nuisance Lawsuit against Mautz Paint and NL Industries, the court cancelled the trial day of January 8, 2007, and rescheduled the trial for May 29, 2007.

Over the past three weeks, three cities in Ohio, East Cleveland, Akron and Toledo, filed lawsuits against eight former manufacturers of lead pigment. The claims raised by these lawsuits include public nuisance and are similar to those raised in suits filed in other jurisdictions. In anticipation of the filing of these lawsuits, Sherwin-Williams initiated action to file a lawsuit in Federal Court naming the city's of East Cleveland, Toledo, Columbus and John Doe cities as defendants. This suit was filed to protect the rights and interests of our shareholders by precluding plaintiff's efforts to violate our first amendment rights, our right to due process and to prevent the inappropriate use of the city's police powers by private contingency fee law firms.

That concludes my review of the quarter. So, I will turn the call over to Chris Connor who will make some general comments and highlight our expectations for the balance of the year. Chris?

Thanks, Bob and good morning everybody. Thanks for joining us today. We spend most of our time on these calls talking about the short-term, the recently completed quarter and the quarter to come. I would like to begin this morning by commenting on two key management changes that will benefit our Company for many years to come.

Yesterday, our Board of Directors approved my recommendation to promote John Morikis to the position of President and Chief Operating Officer of the Sherwin-Williams Company. John has provided outstanding leadership and performance results in every position he has held over his 22 year career with our Company. During his most recent assignment as President of our Paint Stores Group, the segment grew from $3 billion in sales through 2400 Company operated paint stores just seven years ago; to sales of nearly $5 billion through more than 3,000 stores last year. This growth rate more than doubles the market growth over the same period. In his new role, John will assume responsibility for all three operating segments of our Company.

Yesterday the Board also approved the appointment of Steve [Overfeld] as President, Paint Stores Group succeeding John. Steve is also a 22 year employee of our Company and has served as President and General Manager of our Southwestern Division of the Paint Stores Group since 1992. Under Steve's leadership, our Southwestern division has consistently been one of our better performing divisions. Steve has skillfully led the Company's growth in many of our largest architectural, industrial and marine markets.

The true strength of this Company is really in the depth and breadth of our leadership. And well deserved promotions like the two we announced this morning create opportunities for highly qualified and motivated individuals throughout our management ranks to step up. I have great confidence in these two talented executives and in the team of outstanding people who stand behind them.

During our last earnings call, I said we would face tougher comparisons in the second half but that we expected to sustain our strong operating momentum and earnings leverage. I remain as confident of that today as I was three months ago. Although consolidated sales growth slowed a bit in the third quarter compared to last year, the majority of our business remains strong. The two areas of relative weakness we saw in the quarter were new residential construction, which primarily affected our paint stores group and the do-it-yourself market, which was a drag on our consumer group.

I believe these two trends are driving down the overall growth in the market to a more normalized and sustainable range. Keep in mind that over the past 10 years, the U.S. coatings industry volume has grown at an average rate of less than 1.5%, while architectural paint has grown at about 2.5% annually. Despite these softer demands in these two markets, we continue to generate solid revenue growth and positive earnings leverage. Our focus on serving the painting contractor, the fastest growing segment of the market, and our aggressive rate of new store openings at home and abroad will enable us to continue to grow well in excess of the market growth trends.

During the third quarter, our paint store segment opened 19 net new stores, bringing our total for the first nine months to 69 net new store openings. At this pace, we remain on track to open more than 100 net new stores during calendar 2006. At the same time, our roughly 3,000 existing stores posted comp store sales increases of more than 11% during the first nine months of the year.

During the third quarter, we continued to improve our gross margin performance. Through the first nine months of 2006, our consolidated gross margin increased by 130 basis points over the same period last year. This increase is primarily the result of our success in implementing the price increases we announced last year and the favorable fixed cost absorption from increased manufacturing volumes. Despite our significant margin improvement in the first nine months, we will finish the year below the gross margin levels we achieved back in the 2002 and 2003 time frame.

Our gross margin improvement in the quarter was aided somewhat by relatively stable raw material pricing. And we are optimistic that pricing of certain commodities will remain relatively stable for the balance of the year. Our optimism is fueled by three factors. First, dramatic drop in the price of crude oil during the third quarter. Secondly, the improved availability of some essential commodities such as titanium dioxide, latexes and polyethylenes and finally stable natural gas prices.

While it's difficult to forecast in the current environment, our outlook calls for the industry to incur year-over-year raw material cost increases in the range of 3% to 6% for the fourth quarter and approximately 6% to 8% for the full year. For the second straight quarter, we reduced our working capital ratio, as well as our working capital dollars, while supporting a significant sales increase. The decrease in our working capital ratio from 15.1% of sales to 13.1% also represents a year-over-year reduction of nearly $40 million in net accounts receivable, inventory and accounts payable.

For the first nine months of 2006, our net operating cash improved $173.5 million to $536.9 million versus $363 million in the same period last year. The principal contributors to this improvement were an increase of $89.3 million in net income and a decrease of $73.3 million in total working capital compared to the same period last year.

Let me conclude our opening remarks this morning by updating our outlook for the fourth quarter and the full year of 2006. We expect fourth quarter sales to increase 5% to 7% over the fourth quarter of 2005. With sales at that level, we expect diluted net income per common share to be in the range of $0.63 to $0.68 per share, compared to $0.54 per share for the third quarter last year. For the full year of 2006, we expect sales to increase 8% to 9% over 2005. With sales at that level, we are raising our expectation of diluted net income for common share for the year to be in the range of $4.10 to $4.15 per share, compared to $3.28 per share last year.

As a reminder, our guidance for 2006 includes an estimated $0.08 per share charge for the additional expense related to stock options. Again, thanks for joining us this morning and now, we'd be happy to take your questions.

[OPERATOR INSTRUCTIONS] Our first question is coming from Chuck Cerankosky of Ftn Midwest Securities. Please proceed with your question.

Good morning, everyone. Chris, could you talk a little bit about the slowness that you mentioned in the two areas that -- you said softening in the press release? I'm wondering if that is a year-over-year decrease or just a slow down in the growth rate? And how much of it was offset in the store's group by the pickup in the industrial maintenance categories? And when you talk about the consumer group and the sluggishness and the DIY sales, do you see that as being part and parcel of the effort by retailers to speed up inventory turns?

Thanks, Chuck. First, starting with the housing comment and the impact on our store's organization. We have been watching this now for quite some period of time. We believe this is the fifth sequential quarter where we have seen slower housing starts year-over-year.

And we think it's notable that throughout that entire slide we have seen strong performance from our stores, including again this quarter with comp store sales gains north of 7%. So, I think the comment is intended that as we break out the many different segment that our stores service, the housing new residential component, is an important one. It is softening and it is having some impact and that portion of it. However, as we commented, we still think that the other segments look very, very, positive going forward.

On the consumer side, again, a softening. The results for the consumer segment for the quarter are right in line with the same performance they have been throughout the year. And yet, as a number of these retailers have also reported slower comp performance and demands in inventory adjustments, et cetera, we're just feeling the impact of that in that segment.

Chris, if you go back to the paint stores segment, did the sales to contractors reflect a slower growth rate or were they actually down year-over-year?

Chuck, they were up year-over-year but they were slower in the third quarter than the second quarter.

Got it.

Slower increase -- lower increase.

Thank you. Nice quarter.

Thanks, Chuck.

Our next question is coming from Eric Bosshard of Cleveland Research Company.

Good morning. A couple things, first of all on -- in the quarter, could you talk about what the mix of was price and units in the comp number out of stores and what the expectation is for those two figure as we move into 4Q and '07?

For the quarter, pricing was slightly higher than volume. And in terms of forecast for the fourth quarter, it would probably be the same.

Okay. And the -- as far as what you are doing with price, we've heard conflicting things on the market that you're putting in a price increase. What is the strategy or thinking about pricing from this point in the stores?

Eric, we have not announced any pricing activities planned for the fourth quarter or the first part of next year at this point in time.

Have you considered that? You are not back to where your margins were.

Eric, we were always considering it but we have not announced anything at this point.

Okay. In terms of material costs, my second question, you gave us what you thought 4Q would be up 3% to 6%. The rollover in crude and nat. gas considered, what do you think in '07 at this point might be? Could we have a year where costs are down or they're up slightly? How are you thinking about costs?

Yes, we were asking those same questions of our team here and we will give that full guidance in February. We don't have all of that data in, Eric. A number of those discussions are going on as we speak with our raw materials supplier. We remain cautiously optimistic that it should be a better year than we come through the last couple.

Does better mean up less? Does better mean flat? Does better mean down? At this point, you have just been around the industry longer than I have and in an environment like this, what do you think it mean?

I think it means it will be up less.

But not likely to be down.

We will see. Right now, we'd -- I go as far saying up less today. We will give you more guidance in February.

Okay. And then as far as the sales momentum, 3Q a good number, slower than 2Q. Can you talk at all about the experience was within sales momentum in the quarter and perhaps into October, which I imagine is a pretty important month for 4Q?

I would tell you right now that July was slightly higher than the other two months, August and September. But August and September were pretty much flat. And in October we are seeing the guidance is -- we have not seen anything that would change our guidance, Eric.

Thank you.

Our next question is coming from Ivy Zelman of Credit Suisse. Please proceed with your question.

Good morning. With the market as you indicated, Chris, five consecutive quarters of housing starts being down. Year to date, housing starts are down about 9%. And looking at '07, it is some concern that housing starts could be down anywhere from I've heard 25% to 40%. Assuming something is that bearish in looking at your -- the impact on your business, obviously you've held up very well. Would you expect that you could still show growth in same store sale? Or do you think that environment be too dire and probably challenge you as well?

Ivy, we would expect to continue to show growth. As we shared frequently on these calls, that the vast majority of the demand for our coatings is to maintain and redecorate existing structures, including the significant amount of housing that's put in place in the last decade, which is coming up for repainting and decorating a number of those projects as well too. So, as we sit here today, beginning to put our operating plan and sales forecast together for next year, we would expect to continue to show growth in the face of something perhaps as dire as you mentioned

Okay. And then secondly, on the repair and remodel front, you mentioned that at least the DIY, which is clearly not as big exposure than the pro for you but realizing that things have slowed there, many are also concerned that the house has been an ATM machine for many to spend and redo their kitchens and homes and paint, et cetera. What type of forecast are you incorporating for repair, remodel, expenditures to drive your top line into the fourth quarter and into '07?

We don't really have a modal that looks at that. Anecdotally, having gone through these cycles previously in our 140 year history, Ivy, what we have seen is that painting still remains one of the least expensive, most dramatic ways to update that home. And at the ATM machine, the fact that you mentioned in your house has been dried up a little bit, I would think that that would have a bigger impact on carpet, draperies furniture sales. And we would have continued to expect to see the consumers desire to decorate and refresh their home and continue to create demand for our products

And then lastly, with respect to the new product launches or things that are going on that might help accelerate sales incremental to what you have launched so far, do you have something in the works? I know that you always are putting out new products but there is always been some real standouts. Is there anything that you'd like to talk about?

This is the time of year, Ivy, where we are finalizing that lineup of new products, completing testing. I can you there's a number of really cool new things that we are working on. Those typically get rolled out in the first quarter of next year and we would be prepared to discuss those again in our February call.

Great. And I have one last one. CapEx as a percent of sales, it there is any expectations that '07 would be materially different than '06 and any new plans or anything that you might be talking about?

Actually, we believe that '06 will be high water mark for us. And that '07 will be slightly below '06, as we continue to complete the emulsion plant in western United States.

Great. Thanks, Sean.

Our next question is coming from Jeff Zekauskas of J.P. Morgan. Please proceed with your question.

Good morning. This is Silke Kueck for Jeff. How are you? Can you talk about in your stores business, how fast the industrial and marine coatings businesses grow? Did they grow double digit or did they grow slower than that?

No, they were probably consistent with the growth in that segment for the quarter in the high single digits.

High single digits. So, that would mean if industrial and marine is may $1 billion and maybe 25% of the stores business that architectural coatings and all other group -- are somewhere at like at 1% or 2%?

No, I think the architectural coating business for our core business segment, particularly against these figures, was consistent with the kind of number we saw with our industrial coatings as well.

Okay. In the -- on the consumer side, outside of slowing do what you like customer demand and some the inventory balancing, has there been any shift in market share that you can see?

Well, we get those shifts on a broader annualized look as opposed to a quarter by quarter. I think that those trends have historically been moving towards the big box retailers. We continue to see that strengthening. And beyond that, I wouldn't say there is any more finite changes in the quarter.

So, if you look at for the nine month and for the year, what has changed for like the nine months versus the beginning of the year?

For our consumer segment?

Yes.

For us, we commented about the loss of significant volume at one of our major retailing partners. Our sale revenue for the segment has been pretty consistent, every single quarter down slightly. And not a whole lot has changed for us. Continuing to maintain shelf and our partners are doing well and sawing our way through and anniversarying this major loss of distribution.

And then as last question, you said you have seen more of a availability of raw materials like TR02, latex, PE, does that translate also into these raw material costs trending down for those particular items?

A number of those raw materials do have pricing pressures based on supply and demand. As we have seen this softening in the industry there is less demand for some of these things. As we've seen this softening in our industry, there's been a little less demand for some of things. We would expect that would have a positive impact on pricing for those materials going forward.

Thanks very much.

Our next question is coming from Saul Ludwig of KeyBanc. Please proceed with your question.

Good morning, everybody. A couple questions. Could you talk a little bit about the tax rate, why it was up the way it was and what you expect going forward? And also with that the administrative costs that were up $15, $16 million in the quarter and what you expect going forward there?

And the tax rate, Saul, since there has been some change a few years ago, our tax rate on a quarterly basis fluctuates with the discreet and indiscreet items. And just for an example, we were at it 22% in the first quarter of 2005. This year we were at 29.8%. Basically, our statutory rate is 38.5% and we are adjustments down. We were at 35.25% and that take us year to date at 32.5%. When you take a look at our fourth quarter and what we believe, we believe that we will be in the low 30's. Somewhere in that 32% to 33% effective tax rate for the year.

Okay.

And on the admin, John?

Saul, on the admin, we've expense stock option base compensation in the administrative segment. So, that's up over last year due to the stock-based compensation cost and that's roughly 50% of the amount that goes up this year. We would not expect that to continue as it anniversaries in '07. So, the admin spending would come back in line on a much smaller increase

So you were up $15 million this quarter. As part of your guidance for the year, do you think the fourth quarter is going to have a similar increase?

No, it should be slightly less. There are other factors there in the third quarter that won't repeat in the fourth quarter.

Anything unusual going to happen on the environmental costs as we look to the fourth quarter?

No. We believe -- a few years ago again that used to be taken mostly in the fourth quarter. Now on an annual basis each quarter stands on its own, so therefore, we have expensed some. We feel it will be comparable to last year.

And last year in the fourth quarter, if I recall, there was some sort of inventory adjustment that boosted your earnings in the fourth quarter in the stores segment. How should we think about that component of your store results last year when we're thinking about this year?

Saul, we take physical inventories in the fourth quarter and there are always some adjustments that occur in that fourth quarter. But we do not expect anything unusual this year to benefit or cause a decline in the stores profits.

But the fact that you had that benefit last year makes it a little tougher comp?

In makes it a little tougher comp but the benefit should be about the same probably this year.

Similar benefit this year.

That's correct.

Next question. With Lowe's putting in these Martha Stewart new color pallettes, does this in anyway impact your product that you produce for K-Mart?

We continue to sell K-Mart a variety of different important branded programs. The Martha Stewart program will not be one of them going forward.

So, that's something you have this year that you don't have next year?

That's correct.

How much might that cost you?

We've never given any indication of that and it won't be material.

And then finally, in the global sector, that really I think is three businesses. It's kind of your foreign business, your automotive refinish business and your nonauto OEM business. Could you comment about the business patterns in each of those three buckets of business?

They have been fairly strong. That group has had a nice performance for us this year. They remain strong. They are participating in a number of markets where the GDP growth is stronger than with what we are seeing here domestically. We were opening stores in many Latin American countries in support of the businesses that we have down there. And we expect them to continue to contribute going forward.

I was just wondering in relation to the percentage growth that you had in your revenues in the third quarter, did each of those three categories grow about the same or were some stronger than the others?

They were pretty comparable.

Pretty comparable. Okay, great. Thank you very much.

[OPERATOR INSTRUCTIONS] Our next question is coming from John Roberts of Buckingham Research. Please proceed with your question.

Good morning, guys. Could you tell us what your history is in Ohio with lead paint litigations, since I don't know whether we need to think about Ohio being different than other states in terms of it being your home state?

Well, John, our history of litigation in this nature in Ohio is, there isn't one. These suits are unique.

Secondly, the federal case that you filed with the First Amendment and protection and abuse by contingency lawyers, why now? Why wasn't that done a long time ago?

In well, we filed a federal suit in Mississippi at one point. But in Ohio it made sense at this point in time, give than there were a number of cities in Ohio looking at complaints, for us to interject with an action that protected the interests of our shareholders

We've also previously filed suits, John, regarding the contingent fee relationship between states and the trial bar.

Just wondering whether you did it because these suits are now in Ohio and that's why you did the federal case or why you didn't do that in the Rhode Island situation a long time ago?

I'm -- liberty is not the wrong word. I don't just have an answer to the thinking on the legal strategy of why now versus then.

Okay. And then the timing in the Rhode Island case has got to be frustrating. Do you think post the November elections that timing issues will become a little bit more predictable or straightforward? Or is that not a factor at all, do you think?

We were unable and it would inappropriate to try to guess this judge's next steps.

Thank you.

We show no further questions in the queue at this time. I would like to turn the floor back to management for any further remarks

Terrific. Thank you all for joining us this morning. As usual, I will be around for the balance of the day to answer any additional questions you may have. So, please feel free to call. And we appreciate your continued interest in Sherwin-Williams.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.