宣偉 (SHW) 2007 Q2 法說會逐字稿

Good morning, and thank you for joining the Sherwin-Williams Company's review of the second quarter 2007 financial results and expectations for the third quarter and full year. With us on today's call are Chris Connor, Chairman and CEO; Shawn Hennessy, Senior VP of Finance and CFO; John Ault, Vice President and Corporate Controller; and Bob Wells, Vice President of Corporate Communications. The Company has provided information regarding the second quarter and first six months financial results business segment sales and profits, balance sheet items and selected statistical data on their website, www.sherwin.com, under Investor Relations Second Quarter Press Release. Please access this information to supplement comments made on this call. 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 statement 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.

This call is being Webcast simultaneously in listen-only mode by V-call 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 Wednesday, August 8th, 2007 at 5:00 p.m. Eastern time. After the Company's opening remarks, we will open this session to questions. I will now turn the call over to Bob Wells.

Thanks, Joe. During the second quarter 2007, we completed the acquisitions of M. A. Bruder and Sons Paint Company headquartered in Philadelphia, Pennsylvania, and Nitco Paints based in Mumbai, India. Although these acquisitions had some impact on sales during the quarter, they had little effect on profit by segment or consolidated. Summarizing overall Company performance for second quarter 2007 versus second quarter 2006, consolidated net sales increased 3.2% to $2.2 billion, reflecting improved domestic sales of architectural paints and industrial coatings, and strong growth in many markets outside the United States. The acquisitions of M. A. Bruder and Sons and Nitco Paints completed during the quarter increased consolidated sales by 0.7% in the quarter.

Consolidated gross profit increased $50 million for the quarter to $986.6 million and gross margin increased 90 basis points to 44.9% of sales. Selling, general and administrative expenses increased slightly to 30.3% of sales in the quarter, from 30.1% last year, due primarily to our continued investment in new stores and increases in certain administrative costs. Interest expense, net of interest and investment income for the quarter, was slightly higher at $13.1 million compared to $11 million last year, due to an increase in short-term borrowing. Consolidated profit before taxes increased $34 million, or 12.6% over last year's second quarter, to $303.1 million. The acquisitions had no significant impact on profit before taxes in the quarter. Our tax rate for the quarter was 33.2% compared to 31.4% in the second quarter of '06. We expect our effective tax rate for the full year will be slightly higher than our '06 rate of 31%. Consolidated net income for the quarter increased by $18 million or 9.8% to $202.6 million. Net income as a percent of sales improved to 9.2% in the second quarter this year from 8.7% last year due primarily to improved operations. Diluted net income per common share for the quarter increased 14.3% to $1.52 per share compared to $1.33 per share in the second quarter 2006.

Looking at our results by operating segments, sales for our paint stores grew in second quarter 2007 increased 2.8% to $1.37 billion. Comparable store sales, sales by stores open more than 12 calendar months, were flat in the quarter compared to second quarter last year. Sales growth for our paint stores was driven by improving architectural paint sales to do-it-yourself customers, commercial and residential repaint contractors, stronger industrial maintenance coating sales compared to the second quarter last year, and one month of sales from M. A. Bruder and sons. The M. A. Bruder acquisition increased paint stores group sales by 1% in the quarter. Regionally in the second quarter 2007, our Eastern Division led the sales performance, followed by Midwest, Southwest, and Southeast. All four divisions achieved stronger sales results in the quarter as compared to a year ago. Segment profit for the group increased 9.7% to $238.2 million for the quarter. Operating margin increased to 17.4% from 16.3% last year, due primarily to tight expense control and gross margins recovering to a more normalized rate.

In the Consumer Group for second quarter 2007, sales declined $4.3 million, a drop of 1.1% to $396.6 million. This was due primarily to continued soft DIY demand at most of the group's retail customers. Segment profits increased $6.3 million or 8.2% to $82.6 million in the quarter. Segment profit as a percent to net sales -- on net external sales increased to 20.8% from 19.0% in the quarter last year, primarily due to tight spending control and improved manufacturing direct conversion costs.

Turning to our Global Group for second quarter 2007, net sales in U.S. dollars increased $35.5 million or 8.9% to $434.3 million. Stated in local currency, sales grew by 5.3% in the quarter, due primarily to a successful new product introduction in the UK, architectural and automotive paint volume gains in South America, and improved product finishes sales in most markets. The acquisitions of Nitco Paints had no significant impact of sales on the Global Group in the quarter. Segment profit for the Global Group increased $14.8 million or 43.6% to $48.9 million for the quarter. Segment profit as a percent of net sales improved to 11.3% from 8.5% last year. This improvement was mostly attributable to increased sales, operating efficiencies related to increased volume, and expense control. Currency exchange and the Nitco acquisition had no significant impact on operating profit.

I would like now to comment briefly on some of our balance sheet items. Our total debt on June 30, 2007 was $757 million, including total short-term borrowings of $455 million. This is down from $789 million at the end of second quarter 2006. Our cash balance at June 30, 2007 was $57.5 million compared to $248.6 million in 2006. Total borrowings to capitalization were 27.3% at the end of the quarter versus 28.6% at the end of the second quarter 2006. Long-term debt to capitalization was 13.0% at the end of the second quarter this year compared to 20.6% last year. In the second quarter 2007, the Company purchased 1.3 million shares of our common stock in the open market. At June 30, 2007, we had remaining authorization to purchase approximately 8.2 million shares of the Company's stock. In second quarter 2007, we spent $44.8 million on capital expenditures, depreciation expense was $33.3 million, and amortization expense was $5.9 million. For the full year 2007, capital expenditures will be approximately $180 million. A significant share of these capital expenditures will go toward investing in new stores, additional plant capacity, and continued spending to upgrade our manufacturing facilities and replace plants and store equipment as necessary. Depreciation will be about $130 million versus $123 million in 2006, and amortization expense will be about $20 million versus $23 million in 2006.

I'll conclude this review with a brief update on the status of our lead litigation. In Rhode Island, the case remains under appeal. Both sides have now submitted candidates for a court-appointed special master to oversee the process of determining an abatement remedy. It is not clear how or when the selection of this special master will be made. In Ohio, the City of Cincinnati has withdrawn its public nuisance lawsuit against former manufacturers of lead pigment. Of the nine remaining municipal suits, three have been stayed, along with the Ohio Attorney General's suit pending the Ohio Supreme Court's ruling on Senate Bill 117, a bill designed to clarify Ohio's product liability law. In June, the State Supreme Courts of Missouri and New Jersey upheld dismissals by lower courts in each state of the public nuisance lawsuits against former manufacturers of lead pigment. Finally in Wisconsin, a 12-member jury in the City of Milwaukee's public nuisance lawsuit against NL Industries returned a verdict for the defendant. In a ten to two vote, the jury found that although deteriorating lead pigment on buildings in the city may constitute a public nuisance, NL neither conspired to create it, nor was negligent in creating it. That concludes my review of the quarter. So I'll turn the call over to Chris Conner, 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. On these calls, I normally conclude my remarks by updating our guidance for the next quarter and full year. This morning I would like to begin with our expectations for third quarter and full year '07 because I think it will help to set the stage for my comments on the positive progress we have made in the first half and expect to make over the balance of the year. In the third quarter, we expect our consolidated net sales to increase 4% to 6% over the third quarter of 2006. With sales at that level, we expect diluted net income per common share to be in the range of $1.45 to $1.55 per share compared to $1.30 per share for the same quarter last year. For the full year 2007, we expect sales to increase in the low single-digits over 2006. Based on that level of sales growth, we have raised our expectations for diluted net income per common share for the year to a range of $4.60 to $4.70 per share compared to $4.19 per share last year.

This change in our outlook for the year is a reflection of both the strength of our results in our first half and our confidence that we are well-positioned to manage through the challenges that lie ahead in the third quarter and beyond. The second quarter of 2007 was a good quarter for Sherwin-Williams in many ways. We achieved record sales, earnings and cash flow for the quarter, completed two strategically important acquisitions, expanded our controlled distribution platform domestically and abroad, and purchased 1.3 million shares of our stock on the open market. These accomplishments strengthen both our financial position and our competitive position.

Let me take a moment to comment on our acquisition of M. A. Bruder and Sons and Nitco Paints. We often talk about our interest in acquiring companies that add to our controlled distribution platform, provide us with a highly differentiated product and brands, or expand our presence outside of North America. And by these criteria, M. A. Bruder and Nitco Paint are right in our wheelhouse; solid businesses with great talent, well known and respected brands, and great potential synergies for our Company. M. A. Bruder services professional painting contractors, builders and do-it-yourself customers in the Eastern, Midwestern and Southeastern United States through 131 company-owned paint stores in 80 sales territories. These stores and territories will significantly enhance our ability to serve professional painters and do-it-yourself customers in these important regions of the country, and the process of integrating them with our existing stores organization has already begun.

Nitco Paints is a leading manufacturer and distributor of exterior specialty paints and coatings headquartered in Mumbai, India. Although relatively small in total revenues today, Nitco will provide us with a platform on which to grow our presence in the dynamic and growing Indian market. I'm confident these two organizations will contribute to our profitable growth for years to come, although as Bob has commented, neither will have an impact on segment profit or PBT in 2007. During the second quarter, our Paint Store segment opened 13 net new stores, bringing their total net new stores for the first half of the year to 30. At this pace, we remain on track to open around 100 net new stores during the year. Our commitment to control distribution, as we've commented in the past, extends beyond North America. Our Global Group additionally opened nine new stores and branches during the quarter. Including the 131 MAB stores we opened or acquired, a total of 153 stores during the second quarter, and that brings our year-to-date total to 180 additional stores.

There's some truth to the old saying that what doesn't kill you makes you stronger. We are certainly facing a difficult sales environment and we have been facing it for the past three or four quarters, particularly in the new residential market. This has required us to focus our efforts on our other growth opportunities in order to generate continued strong results. While we remain focused on driving top line growth, getting more of those revenue dollars to the bottom line is one of the keys to our success in the second quarter. We achieved year-over-year double-digit increases in profit before tax and earnings per share, despite a slight increase in our SG&A expense, and a near double-digit increase in net income for the quarter, even after a 180 basis point increase in our effective tax rate. Our consolidated gross margin increased by 90 basis points in the quarter, and 120 basis points for the first half, and all three segments posted operating margin increases of more than 100 basis points for the quarter. We made good strides in recovering gross margin over the first half of '07. However, we expect our consolidated gross margin for the year to remain below the historical levels we achieved back in 2003.

We continued to make progress in our management of working capital in the second quarter, a strong discipline in our Company. Although our working capital ratio, accounts receivable plus inventories less payables to 12 month sales increased to 14.1% for the quarter compared to 13.9% for the second quarter of '06, the acquisition of M. A. Bruder and Nitco Paints inflated this ratio by 0.5% of sales. During the quarter we generated $358.8 million in cash from operations compared to $302.4 million for the same period last year, an increase of more than $46 million in cash. This combination of earnings improvement in the quarter and reduced investment of working capital accounted for the increase. Finally, yesterday our Board of Directors declared a regular quarterly dividend of $0.315 per share, up from $0.25 per share last year, continuing our longstanding record of paying out 30% of prior year's earnings per share. Again, thanks to all of you for joining us this morning, and now we would be happy to take your questions.

(OPERATOR INSTRUCTIONS) Jeff Zekauskas, JPMorgan.

This is Silke Kueck for Jeff. I have two questions. When you look at the improvement in the gross margins, how much came from reduction in direct labor costs, how much came from higher prices mix, and how much came from lower material costs?

I would tell you that if you take a look at it, price was the majority of it. I would tell you that the raw materials are very minor (inaudible) and the direct labor is minor also. But the majority of it came from price.

Okay. And secondly, can you discuss what happened in the professional and paint markets in the quarter, and they look softer sequentially and year-over-year. And similarly, PPG commented that it reported lower volumes in the professional channel, as well.

Well I think, Silke, as we have commented in the past, the impact of the new residential housing market slowdown has impacted the professional painting contractors in that segment positively. They have been somewhat offset by strength in some performance growth in the other professional painting contractor segments that we participated in; residential repaint, property management, commercial and industrial. With the exception of that one area, new residential, we see a continued improvement in the professional painting contractor segments that we service.

Thanks very much.

Armando Lopez, Morgan Stanley.

A couple of questions. I was wondering if you guys could talk a little bit more about the margin, and how you are thinking about the margin going forward? You have done a good job of controlling SG&A costs. If you could maybe talk a little bit about where the savings is coming from, and just so we can get an understanding of what you think of a normalized earnings margin -- or normalized margin for the Company.

Armando, if you take a look at our gross margin for the quarter, we are at 44.9%, For the year-to-date, we are about 45%. Last year, we were about 43.8% year-to-date through the first six months of '06. We finished last year right around 43.7%. Right now, we believe our margin will be at or slightly below where we are for the first six months of this year also. So that should give you a pretty good indication of what we think on the margin. Long-term, I think we have shared this with most people. When you look back at -- Chris mentioned historic highs in 2003, which was above 45%. And we've -- from 2003, we've had back to back to back raw material increases. We believe over time that our goal is that we can get above that 45.4% that we had in 2003. We don't believe we're going to -- but I think we've already told you here what we think we are going to be able to do this year.

Right.

When you take a look at the SG&A, and you really look at where we were in the quarter, we were up two-tenths, 30.3 to 30.1. Year-to-date we are up about seven-tenths. So when you take a look at the margin improvement in the second quarter, which was seven-tenths, that was pretty good. We think that is on the high side for the year. But we think that when you look at the part time hours, they're well under control. Again some of the black belt for taking a look at tint usage and how we use tint and the controlling of hours at our stores, as well as freight, those are the things that are controlling our SG&A. And we have been working on those for years. When you take a look at the remainder of the year, that SG&A increase, we think our SG&A is going to go up as a percent of sales, because our sales -- when you hit the lower single-digits, we have always talked that we need 4% or 5% after the new stores to get leverage on our SG&A. So when you take a look at it the second half of the year, we'll have a full six months of the MAB 131 stores and so forth. So when we look at our margins, second quarter was very strong with 70 basis points increase. We don't see that increase in the third and fourth quarter. But for the full year, we are going to have a nice increase in our operating margin.

Okay. And then just as you think about getting back to the historical highs in like '03, is that coming from just improved efficiencies?

Yes.

Or pricing?

I would say that when you take a look at our margin this year, and I answered Silke that the majority of that margin increase is price, when you take a look where we were in 2003 from 2002, it was really the increased gallons through our plants and a lot of efficiencies there. And I think that's what's going to drive us from the 44.9, 45 this year, up to the 45.5 over the next couple of years.

Okay. Thanks.

Eric Bosshard, Cleveland Research Company.

A couple of things. First of all, in terms of the sales momentum, it seems like you're guiding for better growth in 3Q than 2Q, and I know the acquisitions are also having perhaps more of an influence in 3Q. But can you talk about the momentum of comps through 2Q, and what you are thinking about 3Q relative to that?

Yes, I think a couple of things are impacting that, Eric. First of all, the second half of this year has more favorable comparisons. As you recall in '06, we had a phenomenal first quarter, a very strong second quarter, and then the year tended to flatten out a little bit in the back half, so we are going up against those numbers. So the performance trend that we have been on for the first half of the year, I dont' think we see it accelerating as much as we are coming into a little better comparison. Certainly, all the news out of the industry regarding housing starts, et cetera, wouldn't give us any indication that that's going to pick up at all. So it is more a comparison issue for us going forward.

Okay. Secondly, within the increased guidance and the increased performance in 2Q in the second half, is it entirely margin and entirely - I guess what has been different, rather than answer the question for you - what's been different than what you expected that's allowed you to have such upside earnings performance in the -- .

I think there's -- all the areas that make that up in terms of margin and SG&A, et cetera, have had an impact. But Sean, why don't you add some thoughts there?

When you look at where we were at the end of the first quarter, Eric, versus our full year forecast, our margin is not materially different than we thought that it would be. I think that the SG&A control was a little stronger in the second quarter and we are forecasting the SG&A control a little stronger in the third and fourth quarter than what we did in the first quarter.

And then lastly, Chris, can you just talk a bit about your acquisition strategy and thinking. You commented at the outset of looking for acquisitions that broaden your exposure internationally. Can you just flesh that out a little bit more of what you are thinking about?

Sure. I think, Eric, we have been consistent here for some time now on the three formats that we look to expand, and Nitco is a great example of that, in a market with significant GDP growth, emerging professional painting contracting communities, and an opportunity with a great starting point to build a platform going forward. We have built that globally throughout Latin America over the many decades, and I think we have indicated an interest to look a little more aggressively into the growing markets of the world going forward.

Great. Thanks.

John Roberts, Buckingham Research.

The upside was driven largely by cost management. And I would expect you are expecting that to continue into the second half. But you don't seem to be increasing the second half earnings by more than just the upside in the second quarter. So are you expecting it to be more offset in the second half by some additional deterioration maybe in the market?

No, I think when you take a look at the -- when you compare the first half, the first half of the year we had $0.18 EPS improvement. With our guidance between $4.60 and $4.70, we have a $0.41 to $0.51 increase over the $4.19 last year. So we are basically saying that we are going to improve $0.23 -- I'm sorry. Yes, $0.23 to $0.33 versus the $0.18 in the first half. I think that as I said, I think the second quarter, the SG&A up 20 basis points versus a margin of 90 basis points, that's seven-tenths, we don't believe that we will hit that seven-tenths [there] in fourth quarter, but we still believe that we are going to earn more -- we're going to flow through more APS improvement in the second half here than the first half.

Secondly, as you annualize the lost business at the major retailers, should we expect that sales will turn up now in the Consumer segment?

No, I think we've been giving guidance that we expect that segment to be flat to down slightly going forward. As you comment, we are annualizing now the loss of a few of those distribution facilities at a major retailer. But this is not an area that we think will change dramatically going forward.

Because PPG reported this morning, and they had pretty good sales in the mass merchandiser channel. I think surprisingly in that channel. They're primarily servicing one retailer, and that retailer is doing better than the rest. Okay. All right, thank you.

Saul Ludwig, KeyBanc.

As John and I have asked in the past about this administrative line, where you have the $66 million of expense. And when you carve out from that your interest expense, your interest and other income, and your other, it leaves you with a number that was like $50 million of expense in administration versus only $32 million last year. I think in the first quarter you said there was some special items that boosted administrative costs and that they were going to level out. What caused this 50% increase in administrative cost in the administrative line segment?

Actually, Saul, it's pretty much the same answer as the first quarter. And I'll just -- when the first quarter, we were at -- at first quarter we had $50 million versus $40 million. This quarter, we have $66 million versus $58 million. In the -- again, it's really the, I would say the spreading of some benefit costs. And the benefit costs in the second quarter were up $7.6 million. Year-to-date, that's $12 million. So it's up -- the change from $58 million to $66 million was up 8 and the benefits were up 7.6. In the -- for the full year, we're up $12 million in benefits and we're up $18 million. So when you look at the year-to-date -- and let me go to third quarter. Third quarter, we're at 53 versus -- $53 million last year was the hit. In the fourth quarter, it went up to $78 million, and for the full year, it was $230 million. I think that -- I didn't mean to imply that it was only the first quarter. There's -- I would say that some of the costs that were -- what we saw in the fourth quarter is now being recognized in a different quarter. So when you take a look at it, we still believe for the full year that our -- this segment will be up by inflation.

Even though we've had these big increases thus far? You also had a benefit, $5 million less environmental cost. You had a $6 million favorable swing in FX. So there was $11 million of help from those two items that are additional expenses that you incurred over and above what you (inaudible) to the benefit costs.

Right. Just so you know, all foreign exchange is not recorded in the admin section. I know some of it goes actually to the Global Group and to -- but I'm not sure exactly how that break out is between the two.

Okay. Next question, in the stores where you had zero comp store sales, which we kind of expected, would that be a maybe 3% price and minus 3% volume?

Not that strong.

What was that?

It's not that strong.

Well what might be the right answer?

Less than 3% sales and less than 3% volume decline.

Okay. And how much did you spend in the quarter on the two acquisitions and on the share buyback? What was the numbers for both?

The amount we spent on the acquisitions were $149 million. And on share buyback, I will tell you in 10 seconds, here. Well, that's -- year-to-date is $309 million that we've spent on share buyback for the first. But in the second quarter -- .

I can back that out.

Okay.

Okay. And then finally, the results in the Global Group were pretty impressive. And when you think about the Global Group being comprised as your foreign stores, your auto refinish and your OEM non-automotive coatings, could you talk a little about those three buckets within Global and where the drivers were? Not only of the revenue growth, but more importantly the profit growth?

Yes, I think all three of those operating teams inside that segment for us, Saul, all had a good quarter for us. We have been on a pretty consistent performance track here now for a number of years, driven by new management teams, new product introductions, some slight acquisition help in the past. And I would say it's been pretty evenly divided among the three of them in terms of both sales and profit contribution to the segments performance.

And then finally, you saw PPG's announcement on SigmaKalon. Was this a property that you were interested in and you just felt the price was too high? Or was it strategically not of interest to you guys?

Well, we did participate as many of the press releases indicated in the process. As you know, from following this, Saul, we follow a very disciplined approach to determining valuation for our shareholders. And we really can't comment on PPG's approach to that. And we'll just see how it all shakes out.

Okay. Great. Thanks a lot.

Jeff Zekauskas, JPMorgan.

Yes, as a follow-up, the -- when should the MAB acquisition be accretive? And that is, I would have expected it to be accretive this year already.

Yes, I would say that in 2008 it will be accretive. When you -- the reason we say that it's really going to - not a material effect, is just in the first, we are doing some integration. When you take a look at the integration costs dealing with some systems work that we are doing, doing the integration, just the timing, if some of that is going to occur this year. And then those expenses -- then next year it will be accretive.

And one other question. There is a significant reduction in other income and a large improvement -- well, I guess a significant reduction in other expense and a large improvement in other income year-over-year. What are those changes, and are there any gains from assets sales, anything -- ?

Silke, most of the change in other income and expense is due to the foreign currency exchange gains and losses that are on that line. We had significant gains this year as opposed to the FX losses in 2006. There is very little gains on sale of fixed assets.

And maybe the last question on the SigmaKalon acquisition. Do you expect a combined Sigma-PPG energy to exert more competitive pressure in any region, like marine coatings or anywhere else? Or do you think there are actually some opportunities as they try to integrate?

The competitive reaction will be interesting to watch as it unfolds. Obviously, we have very little presence in these markets today. So PPG's potential ownership of them going forward, we don't think has much impact at all on our structure. Whether or not they will build out a better global marine platform again, just remains to be seen.

Thanks very much.

(OPERATOR INSTRUCTIONS) Saul Ludwig, KeyBanc.

A follow-up on that FX where it is included, when you were discussing the segments and Bob Wells was going over those, he talked about that none of those segments had any benefit from FX. So that is why I assumed that the big positive swing in the FX would have all been in the admin line. So if it is not in the admin line, was is it the Global segment that benefited by this $6 million favorable swing in FX?

Saul, when we look at our FX category on the other income and expense, that is one measure of the amount that's in PBT. There is a foreign currency effect throughout the P&L in sales, margins and SG&A. So when we talk about the total effect on PBT, there was little net effect on PBT, although any one single line could be larger.

Okay. Thank you very much.

At this time, there are no further questions in queue. I'd like to turn the call back over to management for closing comments.

Thank you very much, Joe. As always, we would like to thank you for your interest in Sherwin-Williams, and for taking part on this call this morning. If you should have any follow-up questions this afternoon, I will be available all afternoon and be happy to take your call. Thank you very much.