宣偉 (SHW) 2011 Q3 法說會逐字稿

Good morning. Thank you for joining the Sherwin-Williams Company's review of the third quarter 2011 financial results and expectations for the full year. With us on today's call are Chris Connor, Chairman and CEO; Sean Hennessy, Senior Vice President Finance and CFO; Al Mistysyn, Vice President, Corporate Controller; and Bob Wells, Senior Vice President Corporate Communications and Public Affairs. 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 at www.Sherwin.com beginning approximately 2 hours after this conference call concludes, and will be available until Monday, November 14, 2011 at 5 PM Eastern Time.

This conference call will include certain forward-looking statements as defined under US 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. After the review of third quarter results, we will open the session to questions. I will now turn the call over to Bob Wells.

Thank you, Claudia. As always, in order to allow more time for questions, we've provided balance sheet items and other selected information on our website at Sherwin.com under Investor Relations third quarter press release. Summarizing overall Company performance for the third quarter 2011 versus third quarter 2010, consolidated net sales increased $312.7 million, or 14.4%, to $2.48 billion, due primarily to selling price increases, acquisitions, and improved organic volume growth by our Paint Stores Group and Global Finishes Group. Acquisitions increased consolidated net sales 4.1% in the quarter, and favorable currency translation rate changes added 1% to net sales.

Consolidated gross profit dollars increased $66.7 million to $1.04 billion. Gross margin decreased 290 basis points to 41.8% of sales from 44.7% in the third quarter last year. The decrease in gross margin was primarily due to higher year-over-year raw material costs and the dilutive effect of acquisitions completed during the past 12 months. Selling, general, and administrative expenses for the quarter increased 8% to $760.2 million, due primarily to incremental SG&A from acquisitions, higher service costs resulting from increased sales, and currency translation rate changes. As a percentage of sales, SG&A decreased to 30.6% in the third quarter this year from 32.4% last year.

Interest expenses decreased $858,000 compared to third quarter last year, and consolidated profit before taxes in the quarter and increased $4.9 million, or 1.9%, to $260.3 million. Profit before tax as a percent of sales decreased 10.5%, from 11.8% last year. Our effective tax rate in the third quarter this year was 30.9%, compared to 31.4% in the third quarter of 2010. For the full year 2011, we expect our effective tax rate to be in the low 30% range, excluding any impact of the IRS settlement compared to last year's rate of 31.8%.

Consolidated net income increased $4.6 million to $179.9 million, compared to $175.3 million in the third quarter of 2010. Net income as a percent of sales declined to 7.2% from 8.1% in the third quarter last year. Diluted net income per common share for the quarter increased 6.9% to $1.71 per share from $1.60 per share in 2010. Acquisitions and favorable currency translation combined had no significant impact on diluted net income per common share in the quarter.

Looking at our results by operating segment, sales for our Paint Stores Group in the third quarter increased 10.2% to $1.42 billion. Selling price increases and improving domestic architectural paint-sales volumes across most customer segments accounted for most of the increase in sales. Comparable store sales, that is, sales by stores open more than 12 calendar months, increased 8.2% in the quarter compared to the third quarter last year. Regionally in the quarter, our Southwest division led the sales performance, followed by Midwestern vision, Southeast division, and Eastern division. Sales by all 4 Paint Stores divisions increased in the third quarter compared to last year. Segment profit for the group increased $11.8 million, or 5.2%, to $236.9 million in the quarter, as sales growth from selling price increases and volume improvement was partially offset by higher year-over-year raw material costs and selling, general, and administrative expenses. Operating margin decreased to 16.7% from 17.5% in the third quarter last year.

Turning to our Consumer Group, sales in the third quarter increased 3.3% to $351.6 million, due primarily to selling price increases that were partially offset by the elimination of a portion of a paint program with a large retail customer. Segment profit for the Consumer Group decreased $18.7 million, or 31%, in the quarter to $41 million, due primarily to higher year-over-year raw material costs that were partially offset by selling price increases and reductions in selling, general, and administrative expenses. Segment profit as a percent of external sales decreased to 11.7% from 17.5% in the same period last year.

For our Global Finishes Group, sales in US dollars increased to 31.2% to $714.4 million in the quarter; due primarily to acquisitions, selling price increases, higher paint sales volume, and favorable currency translation rate changes. In the quarter, acquisitions increased Global Finishes Group net sales in US dollars by 16.3%, and favorable currency translation rate changes increased sales in US dollars by 3.2%. Third quarter segment profit increased $11.6 million, or 36.3%, to $43.5 million. Higher paint sales volume, price increases, good expense control, and favorable currency rate changes were partially offset by higher raw material cost and the negative effect of acquisitions. Currency rate changes increased segment profit by $3.6 million, while acquisitions reduced segment profit by $2.5 million. As a percent to external net sales, segment profit increased to 6.1% in the quarter, compared to 5.9% in the third quarter last year, as selling price increases and higher sales volume outweighed the increase in raw material costs.

Turning briefly to the balance sheet. Our total debt on September 30, 2011 was $1.169 billion, compared to $1.066 billion in the third quarter of 2010. Our cash balance at the end of the quarter was $46 million, compared to $64.9 million at the end of third quarter last year. Total borrowings to capitalization were 41.7% at the end of the quarter, versus 39.4% at the end of the third quarter 2010. Short-term borrowings increased $162.9 million over third quarter last year to $517.5 million. Long term debt-to-capitalization was 23.2% at the end of the third quarter this year, compared to 26.3% last year. In the third quarter 2011, we spent $28 million on capital expenditures. Depreciation expense was $38 million, and amortization expense was $10.1 million. For the full year 2011, we anticipate capital expenditures will be approximately $150 million to $160 million, depreciation will be approximately $150 million, and amortization will be about $30 million.

I'll conclude my remarks for the quarter with a brief update on our status [letiglant] litigation. On September 8, 2011, the Mississippi Supreme Court, in an 8-0 decision, overturned the jury verdict in the Gaines case and rendered judgment in favor of Sherwin-Williams. Previously, a jury had awarded the plaintiff $7 million for alleged injuries claimed to have resulted from ingesting Sherwin-Williams lead-based paint. The plaintiff asked the court to reconsider its decision. However, we believe it is unlikely the court will change its unanimous ruling. That concludes my review of our third quarter results. So, I'll turn the call over to Chris Connor, who'll make some general and highlight our expectations for the remainder of the year. Chris?

Thank you, Bob. Good morning, everybody. Thanks for joining us. I think our third quarter results were encouraging in many respects, and I'll elaborate more in a moment. But first let me take a few minutes to address the 8-K we filed last night. Following the market close yesterday, we announced that we reached a settlement with the Internal Revenue Service regarding their audit of our employee stock-ownership plan for the 2003 through 2009 tax years. You may recall from the 8-K we issued back in May, as well as the subsequent note in our second quarter 10-Q, Sherwin-Williams received a notice of proposed adjustment from the IRS challenging certain ESOP-related federal income tax deductions and proposing substantial excise taxes and penalties.

The settlement announced yesterday fully resolved all IRS issues relating to federal and state income taxes, including interest. It will result in an after tax charge totaling approximately $75 million, or $0.72 per common share, and a reduction in shareholders' equity of approximately $51.2 million, both of which will occur in the fourth quarter. These charges were not included in Sherwin-Williams' previous fourth quarter and full year 2011 earnings guidance. Although we do not believe the deductions in question violated any tax laws, we firmly believe this resolution is in the best interest of our shareholders. This is a one-time charge that will increase our effective tax rate for the current year only and will not affect rates in future years. Importantly, the settlement avoids the potential for years of management distraction and eliminates future risk and uncertainty.

Third quarter of 2011 was a record quarter for Sherwin-Williams. Revenues of $2.48 billion make this the largest sales quarter in our Company's 145 year history, and $1.71 per share is an all time high-water mark for earnings per share in any quarter. I think the most encouraging aspect of our results was the progress we made in growing sales and volumes. After backing out acquisitions and favorable currency, consolidated sales were up more than 9% in the quarter, and volumes increased both sequentially and compared to last year. All 3 segments reported higher year-over-year revenues, and Paint Stores Group and Global Finishes Group delivered solid organic volume growth.

On our last call, we said we expected domestic market conditions to improve in the second half compared to the first, and that market volume would likely turn positive. Even assuming modest improvement in the market, the sales and volume performance of our Paint Stores Group in the quarter is convincing evidence that our continued investments in new store openings and superior store staffing is translating into market share growth. Our strategic investments outside North America are also bearing fruit. For the third quarter and 9 months of 2011, our Global Finishes Group reported positive volume growth across all lines of business.

SG&A spending increased $56 million in the quarter. However, our core SG&A expense, net of acquisitions, was up a little more than half that amount. Most of this core increase supported new stores open in the past 12 months. The balance went towards maintaining staffing levels in existing stores and funding organic growth in our Global Finishes Group. In total, we reduced year-over-year SG&A as a percent of sales by 180 basis points, which partially offset the significant increase in raw material costs.

My disappointment in the quarter is that we're still being impacted by the rapid increase in raw material costs. The recent decline in petrochemical feed stocks, such as propylene, will provide some cost relief in the coming quarters. However, the pricing actions by the titanium dioxide producers are likely continue for the balance of the year and into 2012. Despite our efforts to help offset these higher input costs, including a round of pricing increases that went into effect in early October, the lag between raw-material cost inflation and higher effective pricing has pressured our gross margin in the second and third quarters, and will again in the fourth. Implementation of our price increases is progressing as expected, and we remain confident that we will ultimately close the gap on input costs, but our margin results in the interim are nonetheless disappointing.

Although input-cost head winds continue to suppress our earnings, we manage working capital efficiently and generated strong net operating cash in the quarter. In the third quarter, we generated $338 million in net operating cash, compared to $241 million in the third quarter last year, bringing our 9 month net operating cash to $446 million. The increase in the third quarter cash was primarily due to $100 million reduction in working capital. 9 month free cash flow, net operating cash less CapEx and dividends, was $233 million.

We continue to invest the Company's cash to expand our control-distribution platform, complete appropriate acquisitions, increase our dividend, and purchase shares of stock for treasury. During the quarter, we bought back 2.64 million shares of our common stock on the open market at an average price of $74.26, bringing our year-to-date total to 4.24 million shares. On October 19 last week, our Board of Directors approved a new share repurchase authorization for an additional 20 million shares.

In the first 9 months, our Paint Stores Group added 31 net new stores, 13 of which were opened in the third quarter. This brings our total store count in the United States, Canada, and the Caribbean to 3,421 stores; compared to 3,368 stores 1 year ago. Our plan continues to call for Paint Stores Group to add approximately 60 net new store locations during the year. The number of store closings in the year will be more in line with our typical low- to mid-single digit pace.

On July 1 we completed the acquisition of Leighs Paints based in Bolton, England. Although a relatively small in annual revenues, Leighs brings some very important technology to our global protective and marine product lines. Leighs is a market leader in intumescent, or fire-protective, coatings. When applied to structural steel or concrete, these coatings prolong the building's structural integrity in a catastrophic fire, which provides more time for evacuation. Intumescent coating specifications are increasing globally, and we have high expectations for this new addition to the Sherwin-Williams family.

While it appears that overall architectural demand in most market segments in the Americas and global demand for most industrial coatings should remain positive over the balance of the year, raw materials will remain a challenge for the foreseeable future. Our outlook for the fourth quarter 2011 is for consolidated net sales to increase 6% to 10% compared to last year's fourth quarter. We expect fourth quarter diluted net income per common share to be in the range of $0.67 to $0.87 per share before the one-time charge of $0.72 per share related to the IRS settlement, all compared to $0.67 per share in 2010.

For the full year 2011, we expect consolidated net sales to increase in the low teens percentage range compared to last year. With annual sales at that level, we are reaffirming our 2011 full year guidance for diluted net income per common share to be in the range of $4.65 to $4.85 per share before the IRS settlement, or in the range of $3.93 to $4.13 per share due to the settlement, compared with $4.21 per share earned in 2010. Finally, last week, our Board of Directors declared a regular quarterly dividend of $0.365 per share, up from $0.36 last year, which completes our 33rd consecutive year of increased dividends. Again, I'd like to thank you for joining us this morning, and now we'd be happy to take your questions.

Ladies and gentlemen, we will now be conducting a question-and-answer session.

(Operator Instructions)

Stephen East, Ticonderoga Securities.

Thank you. Good morning, guys. Chris, if we look at the TiO2 outlook -- what you talked about -- I appreciate the commentary. One, what are you all seeing coming through the pipeline? And two, what type of alternatives do you all have? And I know we've talked about this in past quarters, but are you to the point where there other sources that can move the needle, or different formulations, that type thing?

Yes, I think we've commented, Stephen, that our expectations for the industry is that raw materials would finish for the year somewhere in the high teens to low 20% range. Clearly, titanium has been the driver, primarily, of that growth this year. And we've seen numbers from other analysts in the range around 40% year-over-year pricing in titanium. I don't think much changes in this forecast relative to how the year tracks regarding those numbers. 2012 will remain to be seen, the amount of pricing. But from my earlier comments, you can see that we expect to be dealing with titanium price increases going into next year. Sherwin-Williams, our competitors, and other raw-material suppliers, have all spoken about various replacement technologies. I think the reality is that our industry is going to be relying primarily on this important raw material for a long period of time yet to come.

From a geographic perspective, are you seeing alternatives in sourcing that could make a difference in 2012?

Again, I think we've talked publicly about some of the emerging titanium producers and technologies around the world, and some of those are in fact finding their way into our operations. But again, I don't think there are substantial enough volumes to make a significant difference in the overall market environment.

Okay, and just the other question I have is on the consumer side. Your margins got pushed him quite a bit. Is this -- do you see it as a lack of pricing power, or just really trailing and having a much longer lead time and getting those -- that pricing through?

Yes, Stephen, this is Sean Hennessy. Just talking about the consumer margins in the quarter. One of the things that happened this year is we really changed production plan and really front-loaded our production plan for the year, which resulted in higher inventory in the first and second quarter. And what happened in the third quarter is our inventory in this area came down. It was reduced. So, usually you'll see that in the fourth quarter. So what happens is that in the third quarter, our inventory production plan was lower versus last year's third quarter. Operating margin was depressed in the third quarter, and our fourth quarter margin will not drop sequentially at the same rate as last year's. Couple other effects of that was the cash. You saw -- as Chris made his notes, cash was up over $100 million, and that was a direct -- correlated exactly to the same issue.

Okay. Very helpful. Thank you.

Thanks, Stephen.

PJ Juvekar, Citigroup.

Hi, this is Dan Jester sitting in for PJ. I just want to talk a little bit about the segments of your business that are more industrial focused, like product coatings or protective marine. Have you seen any slowdown, given what we've seen in the broader economy over the past few months?

No, Dan, those businesses are performing fine for the Company. They tend to be more at the higher end of the kind of volume numbers that we've been talking about.

Okay, great. And then in terms of the price increase you announced in October, could you give us a sense of how large that is? And then looking back to the June price increase, how much of that has been implemented? And can you give us a trajectory for how you expect the rest of that price increase to go through?

Yes, the October price increase was announced through our Stores organization. I think as the investment community knows, that's the one that we're usually the most transparent on. The pricing was around 8% to 9%. That's on top of pricing taken, as you mentioned, earlier in the year. In fact, this was the fifth price increase that we've taken in the last 20 months. All told, those 5 increases cumulatively amount to just shy of around 30%. Historically, our net effective tax -- I'm sorry, our net effect of price increase has been in the 75% range of what we've [gone out for]. This last price increase is off to a good start and tracking right in line and tracking with those past historic performances.

Great. Thank you very much.

Thanks, Dan.

Bob Koort, Goldman Sachs.

Hi, good morning. This is Brian Maguire on for Bob. Just on that last question on the price increases, one of your peers talked earlier this week about some price fatigue setting in with customers, and you mentioned this is the fifth price increase in the last 20 months. As I imagine, those conversations get harder each time. What are you seeing in the channel, maybe more in the consumer business and in your own stores? How are your customers downstream of you adjusting to all this? And how much of it do you -- how much of the announced price increases do you expect to get going forward?

Yes, I'll take the first half of this and then let Sean comment as well. Clearly, there's price fatigue. There's price fatigue on our part as well, dealing with the raw-material cost pressures that keep coming in. The frequency of the pricing activity that we've just talked about, again, as a reminder, is through our Stores organization. So, we don't take pricing as frequently as some of the other customer segments. We tend to go in smaller increments and more frequently. And I think as we've shared with the investment community over the years, the unique business model that we have servicing professional painting contractors and through our own stores, we tried a little better run to market for us to implement that. Sean, I know you had some thoughts as well.

Right. I think when you take a look at it, I'd just like you to point out a couple numbers. If you look at the operating margin, really, in the Stores Group, we were down 0.8% in the third quarter, but for the 9 months we're 0.2% below last year. I do think that there probably is some fatigue, but I think that gives you some comfort that pricing is going through, and we're managing through that. And again, when you take a look at the consumer margins, as Steve asked earlier, our margin year-to-date is down over 300 basis points, but I think that's going to -- again, that was due to some timing of production and inventory. By the end of the year, I think that'll be tremendously closer than it is today. So, I think those numbers give you some kind of comfort that we're really starting -- we're still able to have pricing power in the market.

Okay, great. Thanks. And just a follow-up on the inventories. How are your levels now compared to normal seasonality? And would you expect to be doing some were pre-buying our differentiated abnormal seasonal patterns on your inventory build if you expect raw materials to continue going up? Is there any thought of taking advantage of the seasonal slowdown in the industry and building some inventories in the fourth or first quarters?

Yes, our finished goods inventory, when you go back 2 years, really, because last year we had a different kind of finished-goods inventory problem. But if you look at it compared to 2 years ago, we feel pretty good about our finished-good inventory with the reduction in the third quarter. We're probably real close to where we should be. Raws, on the other hand, are slightly higher, and I think you pointed that out, and I would suggest that we're going to -- raws will run high until we start to see the raw materials turn. And that's how we are managing that. But I think you're going to see raw materials higher in the short term.

Okay. Thank you.

Thanks, Brian.

Greg Melich, ISI Group.

Hi. Thanks, guys. I wanted to get a little more into the timing of the progression of gross margin. If you look in the quarter, how much of the sequential 100 bps worse gross margin was the production issue? Was that basically all of the issue, Sean?

No, but it was the majority, and you're looking at the 100 basis points. I think that what we look at in third quarter was -- that was going -- that's really going to be the lowest gross margin that we report on a quarterly basis this year. And we actually think that sequentially, you'll see our gross margin rise in the fourth quarter. If I was giving a forecast, we're at 42.7%. Year-to-date, I think we'll get close to the low end of the range that we talk about, the 43% to 46%.

Got it. And the fourth quarter, that qualitatively, that progression improvement, is that coming from the production shift, or does it actually come from the raw material price lane playing out the way it should?

I would say it has a lot to do with the pricing. You know, as Chris just mentioned, we just put a price increase in the first week in October in Stores, but we are going to have some positive because it's going to basically -- we had to take the positive or the negative sometime with a production plan. We took it in the third quarter versus fourth last year. So that will help us in the fourth quarter.

Got it. And if I could have just one more question on the acquisitions. I think in the past, you talked about adding maybe $450 million in total sales, but we lost little money in the quarter related to acquisitions. Is that $450 million still the right number? Is there a sign of any volume shifts, in Europe in particular, that we should be aware of?

No, that's a good number, Greg. We're tracking right on in.

I think the loss, Greg, really, when you take a look at it, came from the acquisition we completed in the third quarter. The acquisition, the inventory step-up and so forth, really, 100% of the loss actually came from the Leighs acquisition that Chris mentioned during his comments.

Got it. Thanks a lot.

Thanks, Greg.

Chuck Cerankosky, Northcoast research.

Good morning, everyone. Chris, when you're -- to look at the pricing resistance issue a little more, can you differentiate between how architectural contractors are dealing with paint-price increases versus industrial contractors, especially in North America?

Yes, I don't think there's a lot of difference between the two, Chuck. I think we're blessed with the customer in both of those segments that appreciates quality materials, stayed loyal to that, have a higher labor component to a finished job than just the material costs. For the most part, pricing actions both those segments are tracking as they have historically for us.

Okay. And then, [Pete] -- Excuse me? Okay. And then following up on the volumes, could you talk about in Paint Stores, in Global, where you saw the volume increases, which end markets were strongest? And can you be a little more quantitative about how high volumes did increase?

Yes, I'll give you the color on the segments and customer pieces, and I'll let Sean comment a little bit on -- just to get you closer on the numbers. In terms of the Stores business, as you know, we break out the DIY as one big group, [but in] the contractor segment, we break out pretty much across all the other pieces parts. As we've been commenting for some time, the residential repaint activities are the strength of the market. We've seen that.

Obviously, DIY is essentially a residential repaint market in and of itself, but the painting-contractor segment that's focused on that has continued to show some signs of strength for the Company. We were pleased to see some growing signs of volume strength in the other segments. We commented earlier in the year regarding the importance of property management. We're seeing some of our commercial repaint activity pick up as well, and [the protective] and marine has been fairly strong for the Company throughout the year. The one segment, obviously, that remains a little bit of a lagger would be in that new residential area.

Right. And when you look at the Stores Group, we were up 10.2% for the quarter. Stores were up about -- were up 8.2%, Chuck. When you take a look at it, we feel pretty good about where we are with the selling prices. But as Chris mentioned, some of the segments have changed. You're starting to see not a mix change by customer -- customers are not changing mix -- but because of that, it does change how much the average selling price will increase, just because [the different basis]. But our selling price increases in the mix -- that's 4% to 6% selling price increase in the quarter. And so the difference on the comp store is [the gallon gain].

And just then to conclude the question, Chuck. Regarding the Global Finishes Group, all 3 segments that we report there, product finishes, vehicle refinish, and the protective segment all were very comparable and very nice solid gallon performance in the strong revenue that we already commented on.

So if I -- just to go back to Paint Stores. So taking 4% to 6% away from the comp number gives us some comp volume growth.

Yes.

All right. And would you see that level of volume -- a similar level of volume growth in the Global Finishes segment?

Yes.

At least.

All right. Thank you.

Thanks, Chuck.

Eugene Fedotoff, Longbow Research.

Good morning, guys. Thanks for taking my question. Can you comment on the trends that you see in markets in the Global Group, particular in Brazil and [Mexico]? And also if you can comment on the performance of your required business in Europe and your expectations for those businesses in fourth quarter?

Yes, I think the -- we've talked about the Latin American market, where Brazil and Mexico reside. It's embedded in that Global Finishes Group, which as we indicated, was at the high end of our sales performance of our 3 segments. And the Brazilian and Mexican businesses are very much in line with the kind of numbers that we've commented on. I think regarding the acquisition specifically, we don't break them out individually. There was an earlier caller that asked is if we were on track with around this $450 million impact, and we said we were. So, I think, Eugene, that these are all performing on pro forma and as expected.

Great. And then on the price increases, Chris, you had said that you announced 8% to 9% price increase in October. Just wondering if you're [playing] -- if this price increase is going to be enough to close the gap raw materials and pricing costs start to stabilize here and [to add to] and continue to increase? Or do you [plan] for additional price increases towards the end of the year or maybe early next year?

I think Sean commented earlier that we felt that by year-end, we would probably be in the range of the margin guidance that we've provided for while now, in the 43% to 46% range. Historically, the Company has operated at the peak of that range, and we're guiding that we'll be in the lower half of it. So that would indicate that we don't have all the pricing required to be back at the historic levels. The Company does not comment on prospective pricing actions, and we'll wait to see how the market responds on a number of fronts and give guidance to the Street if and when we decide to take more pricing in the coming year.

Okay. Thank you.

Eric Bosshard, Cleveland Research Company.

Good morning. Thanks. First, on the volume front, I think the store volumes [okay] they were down 2 or 3 points in the second quarter and up 3 points, roughly, in the third quarter. Can you provide a little more color in terms of what changed? And then also if this up 3% is the new volume run rate we should assume as we head into 4Q and perhaps into 2012?

Yes.

If you could start there, that'd be great.

Eric, I think just to remind everyone, last year we felt that the government put a program for new home buyers that really pulled some sales forward. If you remember, I'll remind everyone, March was very strong, and April was very strong. May was very strong. And we -- and then you started to see the slippage in the third and fourth quarter. From our standpoint, we believe that the total-year volume was probably but not affected, but what happened with the timing of that, we had to go -- was brought forward. This year, we are going against that in the first and second quarter. We went through that, and as you said, really caused that decrease. Having said that, and we think that fourth quarter will look a lot like the third quarter. Having said that, but when we talk about sequentially and so forth, we still feel pretty good about the second-quarter volume in the Stores Group second to third quarter. We think that there was some increases there. But we think that just because of that major dramatic changes that that program caused second and third quarter last year caused major portion of the negative to positive.

And then secondly, Sean, can you explain -- I understand how the consumer down time hurt the margin in the third quarter. I guess I don't understand why you then produced more in the fourth quarter now that you've made this progress with inventory?

We don't.

We don't. What happened was now that we've got inventory down, you're not going to see it come down. But what happens is when your inventory comes off the balance sheet, you're expensing that conversion in a different quarter than what you produce it. And that's what happened to us this year. And that's why I think that when you see the quarterly -- last year, our drop between the third and fourth quarter in the Consumer Group went from $17 million down to $10 million. You're not going to see that same dramatic decrease off the $11 million, $7 million that we produced this third quarter.

That's on a sequential basis. On a year-over-year basis, it looks similar. It just won't drop sequentially? Is that the right way to think about it?

Yes. I think -- I usually don't do this, but I would tell you that the segment probably will have a higher operating margin in the fourth quarter, even with the raw material headwind.

Why is that?

Because of this drop that we took in the third quarter that won't repeat in the fourth.

And then lastly, on gross margin, is -- do you have visibility, or how should we think about -- I understand the 43% to 46% range. At what point do we get to where we have stabilization in gross margin on a year-over-year basis?

Well, a lot of this, Eric, is obviously predicated on the raw-material costing environment. So, if you can answer that part of it for me, when we're going to have stabilization there, we'll tell you what we're going to stabilize. As you know, we're going to continue to put pricing into the market on the heels of raw-material cost pressure to us, and so it's going to take some time for us to recover.

Okay. Thank you.

Thanks, Eric.

Dennis McGill, Zelman & Associates.

Hi, good morning. Thanks. First question, back to the raw materials as we think about 2012. Of course I think you said we'll see, and we're not sure about some of the forecasts go. Just given where costs and how costs phase in this year, if you just tell material costs constant, what would that imply for the basket next year?

I think, Dennis, to that point, if we were able to freeze raw-material costs right where they are today, we'd still see a mid-double-digit price increase next year and into teens.

A mid-double-digit increase on raw-material costs?

Yes.

Yes, okay. And then separately, and I'm not sure how much you want to get into the details of competitor actions, but realizing one of [them] is pushing more aggressively into the pro side of the paint aisle, and seeing increased presence of going after your contractors, can you talk about how you guys think about that as a competitive [strat]? Whether these are different types of subcontractors that might be doing multiple things, as opposed to just paint, or other ways to frame that versus any other threat you usually face in the market?

Sure. We have terrific respect for all the big-box competitors that are in this space. We have watched for decades, essentially, Dennis, and see the same demographic shift towards the painter that we've been watching and a number of initiatives and programs that have been introduced to attract that customer into their footprint. It's incumbent upon Sherwin and the other operators of the specialty-paint store chains to continue to do the things that keep that customer loyal to our channel. I think those actions are afoot. You see that simply as continuing to open more convenient store locations, as well as the caliber of the talent we put inside the store, and the technology and the product that's being introduced. So all those things continue to keep this customer loyal to the channel.

Having said that, we think that these are very compelling competitors, and we have to continue to pay attention. You make reference to the -- the more -- not so much the painting contractor specifically, but more the remodeling contractor, or what we sometimes referred to as the handyman who might be buying multiple home-improvement products, not just in the paint category, and that's a more appropriate customer to be in those boxes. We think that is happening, and time will tell where this all shakes out. We remain committed to being the retail location of choice for the professional painting contractor and like our chances going forward.

And you -- to the best that you can measure volumes in the quarter, at least holding shares? You feel comfortable with that 3% volume that's enlarged the market or better than the market?

Absolutely.

Okay. Perfect. Thanks.

Thanks, Dennis.

Kevin McCarthy, Bank of America Merrill Lynch.

Yes, good morning. With regard to your protective and marine coatings business, can you advise us how that would split in terms of OEM versus repaint? And also protective per se versus marine, I would've thought you'd see a little volume pressure on the marine side, but it looks like it's netting out to positive.

Yes, it's been -- that's been a pretty solid category for us, Kevin, and as with the architectural business, the amount of new build, or the degree to which new build is driving that category, is way down. So normally, it could be as much as 20% of volume going into new build. We would suspect that in this environment, it would be close to half of that, maybe 10% to 12%.

Okay.

The repaint side, the recoat side is the piece of the business that's holding up quite well.

How would it split, Bob, between protective and marine?

The market -- I'm not sure the split in the market -- in our business, we are skewed very heavily toward protective.

Okay, great. And then Sean, with regard to the Board's new authorization of an additional 20 million shares to be repurchased, can you comment on broadly on the expected pace of execution there relative to your old $30 million authorization put forth in October of 2007? Is there any reason to believe it would be different over a multi-year period?

I'm glad you mentioned that 2007, because this 20 million is really not anything new to this management team. We also received 20 million and 2005 and 2003. So it's been an ongoing program. I think the way we've been purchasing the stock is pretty consistent of what you're going to see in the future. It's not that we are always trying to do 4%, but it's interesting, when you look over the 10-year period, annually, it's been at least 4% every year. I think that again, the cash we're producing, we're even looking for acquisitions. The dividends are important to us. The CapEx and [way to] acquisitions, you're going to see still see us buy stock. And as Chris mentioned one time, in 41 straight quarters we've been -- we've purchased stock. So I think you'll still see us in the market every quarter.

Very good. Thank you.

Thanks, Kevin.

Chris Nocella, Barclays Capital.

Hi, good morning. Just going back to the question on volumes, given that architectural coatings [has been weak for] many years now, how do you think of the potential for pent-up demand, given that people have delayed remodeling projects? Basically, do see the potential for higher volumes even if the housing market turnover, specifically, remains pretty depressed?

Yes, Chris, we have been commenting that the residential repaint market will be rebounding, and as Bob said, mainly on the maintenance side. A good part of that is because of this pent-up demand. A number that I can maybe share with you that will get you some comfort around that is that we've been talking about the US architectural coatings industry at its peak 4 years or so ago produced 800 million gallons. And that number's dropped to just below 600 million gallons. If you back out the housing-bubble impact, it had new-home construction and new commercial construction and more normalized historical run rates, not bubble rates, the industry should be somewhere in the 725 million to maybe as high as 750 million gallons. So we think that as the new construction comes back, it doesn't account for all that growth from 600 million to the mid-700 millions. There's obviously pent-up demand on maintenance, both residential and some commercial as well. And I think that will be the strength of this market for the next several years.

Okay. And as those volumes improve, how do think of the need to add [collect] in this environment?

I'm sorry. I didn't really get the relationship there. Could you asked the question again, please?

Look, if you have improving volumes, your need to add SG&A costs --

Oh, yes. I think when you take a look at it, there will be some incremental, really, but I think that SG&A at this level, we think that are over 90% fixed. And the reason it's so high is because we consider manpower in the store being -- to have [an accurate] is a fixed cost. You don't open a store without a manager, assistant manager, and the right staffing. So, when we look at what we're able to do between 2002 and 2007 and look at the incremental -- how much we brought down to the bottom line in incremental income, we think that we could actually be slightly higher than that if it goes back up to that 725 million to 750 million range. And we think our capacity -- where we're running at capacity gives us some nice incremental flow-through.

Thank you.

Thanks, Chris.

Jeremy Brunelli, Consumer Edge Research.

Hi, good morning. Thanks for taking my question. This year, we've had an unprecedented number of major weather events, hurricane Irene most recently, the tornadoes Midwest, et cetera. Do you have any sense of the acceleration in volumes and paint projects in your domestic market, whether they have anything to do with these weather events? And then just a second question. When you look at the repaint and architectural demand, is any sense that there is an increase in average projects size or total number of projects that you're getting from the survey work that you do at the paint-store level? Thanks.

Jeremy, first comment on the weather. I think that yes, Irene was certainly an impact up and down the Eastern seaboard, but as a country, we take some form of hurricane weather activity every year. We take various rains and snow storms, et cetera. So it's rare that the Company comments on whether having either a negative or positive impact on the organization. We have seen from time to time geographically some impact on these, but Irene would not have been the caliber in that would've done that. Katrina moved the needle for us in the southwestern part of the United States. Various other hurricanes, historically, in Florida might have, but I don't think that those things will move the needle or are having an impact in the third-quarter volumes that we've been talking about. In terms of the repaint projects we're seeing relative to average size or scope, I don't think there's a lot of change in that at all.

The only thing I'd say on that, Jeremy, is that given that residential repaint has been where most of the strength in the market has been over the last few quarters, those tend to be smaller projects than the commercial projects. So if we see a meaningful rebound in commercial volume, that probably suggests larger project size.

Do you have any sense that whether these are projects that are done jointly with other parts of a project, like a kitchen remodel, or are these projects mostly focused around just doing a paint project and that's it, no other aspects of the project?

Given that large ticket home-improvement projects are down, I would say that the growth we're seeing in the residential repaint market, which has been modest but it's been positive, are likely maintenance painting projects and redecorating projects, as opposed to the tail end of large capital-improvement projects.

Great. Thank you.

Thank you.

[Silka Koopf], JPMorgan.

Good morning. On average, at the volume growth on mature wins looks higher than what's reported by some of your global competitors. Can you talk about where you may have gained share?

Yes, I think, Silka, that clearly, in the painting contractor segment that we've been talking about, we're pretty confident that this has been a share-gaining cycle that we've been through, and the third quarter would confirm that as well. I think our DIY performance in our Stores Group also has been a share-gaining performance. It's been performing right in line with the high-revenues number that we've been commenting on through the Stores, and the volume performance has been nice there as well, too. Obviously, we have commented publicly about our Consumer Group's loss of a significant retail partner, so I think all in, when you look at the DIY segment, the puts and takes are probably more on the flattish area. But clearly, against these professional painting contractors across all the segments, we're continuing to gain share.

And in terms of raw-material costs, I think earlier you said that if raw materials stayed flat from where they are today, it would be up low double -- or low or mid-double digits in 2012. And does that factor in any decreases in propylene cost, because when you look at any of the projections for propylene cost, one would think that eventually your [core] cost would be down double-digit if they say where they are today.

Yes, we don't disagree with that, but I think the question was if the raw material costs to us stayed consistent, where would our overall input cost be throughout calendar 2012. And that was the comment that we would be in the low- to mid-teens. If propylene turns over and we start to see that [pieces] pricing come through our raws, your thesis is correct.

What's normally your lack? Anybody can look up propylene prices. If you look at what propylene prices do and how long it takes for [chronic[ prices to change --

We should be seeing the drop in propylene flowing through that portion of the raw material basket in the next quarter or two.

That's helpful. Thanks very much.

Thanks, Silka.

Gregg Goodnight, UBS.

Good morning all. Hi. Would you comment on -- price aside, would you comment on TiO2 availability in inventories you're seeing out there, both now and your commitments for sourcing TiO2 looking for 2012? Do you see any issues there?

We've had no issues at all, Gregg. [Core] supply is fine for this year as well as the foreseeable future.

Okay. In terms of inventories and availability, are things fairly balanced?

In terms of our inventory?

Yes, your reading on the industry.

Yes, I think we're fine. I don't hear any stress in the industry where we're unable to get inventory on raw materials.

Okay. Second question. Bob, is -- in terms of lead paint, is the Gaines case the final battle there? Or do we -- is there -- is that the last chapter on the lead paint?

There are a handful of personal injury suits still pending, Gregg. I think we have one in Mississippi and a couple in Wisconsin. There's also the matter of the public nuisance complaints still pending in California, which we are in a discovery phase now. And it's slated to go to trial late next year, but we'll see if we stick to that timing.

Okay. Great. Sean, TiO2, year-over-year increases, what percentage of your total year-over-year raw-material increase did the TiO2 contribute?

Yes, I think most of the time we do talk about the basket, and we still believe that the basket'll increase in the high teens and low 20% range. When you take a look at that, the majority of it is that titanium dioxide.

Okay. Okay. Last question if I could. The experts are talking about TiO2 price increases, switching from a TiO2 constraint to an ore-constrained situation. In fact, they're talking about rutile prices averaging $720 a ton this year going up to $2,000 a ton by 2013. My question to you guys is have you looked at the ore situation? Do believe that ore prices could potentially fly by a factor of 2 or 3 for the high-grade ores?

Yes, Gregg, we are aware of the ore implication. I would say for the first and probably in 3 or 4 of these titanium runs that I've been involved in, we've actually done a little but more work through the providers of TiO2 to the ore manufacturers. So we are marginally up to speed on some of the economics that are facing that. I don't that we really have an opinion or comment on that at this point in time.

Okay. Well, thanks for your questions and patience.

Thanks, Gregg.

Carly Mattson, Goldman Sachs.

Hi, my question was actually answered. Thank you.

Thank you.

Don Carson, Susquehanna Financial.

First question is just on your guidance. $0.67 to $0.87 is a pretty wide range for the fourth week in October. Just wondering what puts you at the top, what puts you at the bottom? And I know you've had an improvement in volumes as quarter, but obviously you're coming off some tough comes the first half. So it is volume upside you see? Is it just something breaking on price realization going through quicker than expected? Just what drives that wide range so late in the year?

Yes, Don, there's really just one factor, and you're very accurate. We feel pretty good at where we think sales will come in, what we think is going to happen with the SG&A, what we think our interest expense and so forth will be. It really comes down to this costing and how much cost will come in and the effect on our LIFO reserve for the year. That's the probably the number-one reason that the range is -- the range -- without that volatility in the gross margin and really caused by two things. We'll see what our cost of goods sold are in the fourth quarter, and as you know with LIFO, that's last in first out, so, we'll see what happens. That's the LIFO reserve as well as the raws are causing that.

Then a follow-up on the consumer group. I guess you're close to [lapping] the loss of the color place business. Was that much of a volume for you in the fourth quarter of last year, because I guess at that time, you knew that would be running off anyway. So is that part of the improvement in consumer margins as well, that the comps get a little easier?

Yes, not actually in the fourth quarter. Fourth quarter was still a fairly strong quarter for us. Not only for the color place that we were providing, but if any of the other 3 vendors had any type of issues as far as providing, we were doing -- providing for their products. Fourth quarter was still a pretty good quarter for us with that Wal-Mart business. Really, third quarter, you're going to see the annualization.

Chris, you talked in the past about the potential for perhaps becoming a second source of supply to one of the big boxes. Any progress there? I know in the past, there's been hang-ups over branding and things like that, but is there any update you can provide us there?

No, nothing to comment on that at this time, Don.

Final question. You talked about how you gain share. Is that a case of your gaining more of the contractor business? Or do think that this contractor versus big-box dynamic has played out? That as you said, some of the handyman and remodelers who buy from big boxes -- that that's taken some share from the contractor market. So just wondering whether these are just market-share gains that you've had or whether it's an improvement in the overall contractor big-box [space]?

Yes, we talked publicly about the split in the market between the pending contractor purchases and all other categories, which would include DIY primarily, but also some of this remodeler. Anybody that doesn't generate more than 75% of their revenue from applying paint, we don't consider a painting contractor. That shift has moderated at 55% of all purchases for painting contractors. It's the second year in a row. So after seeing it fall for a couple of years due to the fall-off in construction, that's moderating. Relative to the shift between that and the big boxes, we haven't seen any movement from the contractors as far as the big boxes. So the share gains that we're speaking of, and when we talk about share, we're going into the individual segments, that we gain more share specifically against the [res] repaint contractor, the commercial contractor, et cetera. And that's where we told you that we were quite confident that this has been a share-gaining cycle for us against all those subsegments.

Thank you.

Thanks, Don.

[Nils Wallin], CLSA.

Good afternoon. Thanks for taking my question. Just little bit further detail on the share gains. Just trying to understand what you would say is driving that. Is this better quality, better service that you've seen people shifting away from competitors? Or would you qualify it as competitors that are saying we just can't really maintain the business as it is. We don't have the control distribution. It just doesn't make sense for us and are leaving the marketplace?

Yes, again, speaking specifically about the painting contractor market in North America and their strong preference for the specialty-paint store channel, we think during the cycle that we've seen north of 1,000 locations close. That would be small mom-and-pop, independent dealer, as well as some of the larger national and regional chains that we compete with [through] both locations. Just on a door count alone, the share position has improved. I think when you look inside that, in each of our calls over the last several quarters we've talked about the strategic decision the Company's made to keep staffing levels in the stores at high levels. That's why our SG&A peaked, and I think, again, that's the key component to keeping contractors loyal to that footprint. So, all those things will be part and parcel of why that share shift is moving toward the Sherwin-Williams store footprint.

Got it, thanks. And then with regard to overall pricing mix, and next year you said of course the raw materials [seize them up] even if they stay flat in the teens. Is there any way even as you had tried to get price increases just on the raw materials side to improve your mix, so that overall, whether not you recover your raws, you're still getting stronger pricing?

You know, over the course of time and through all of these, usually we do see a positive mix change for us on the gross margin side, as well as toward the higher quality products, and then with new products that, again, occur. So I think the next year we're going to be more of the same. I think we're going to see positive mix for us in 2012, and as Chris said, when you annualize where we're at just early, you do have a raw material increase. And with the pricing that we did in October that's going to be annualized next October, I think you're going to see price still be a good-sized factor for increasing sales next year.

Thanks very much.

Thanks, Nils.

Ivan Marcuse, KeyBanc Capital Markets.

Hey, guys. Just a quick question. On the consumer side, do you expect the same production trends next year? So meaning build-up of inventory in the first half and then working it off in the second half? Or do expect to continue or go back to where it's been historically?

Yes, I think right now, we're going through that planning process, and it really has come down to what we think is going to happen with the raws and so forth. I would tell you, it's probably -- even if we repeated it, it would not be as dramatic as it is in 2011. Would we bo all the way back to where we were in 2009? I don't know. But we are finalizing those plans right now, but I don't think it will be as dramatic as this year.

Great. Thanks for taking my question.

Thanks, Ivan

Chuck Cerankosky, Northcoast Research.

Hey, Sean, I'm looking forward, too, to 2012 about the Consumer Group. Just trying to get a little input from you on -- with the complete cycling of the business, decline at Wal-Mart, and maybe a new production cycle at the Consumer Group in 2012. What should we be thinking about in terms of sales increase and the cadence of the margin shifts year-over-year?

I think that over time, we've talked about long term, we think it's going to be flat, up slightly. I think that when you take a look at the Consumer Group right now, probably is going to have a little more price than normal in that next year. But I would say that's -- and with a more normalized production rate, I think you're going to -- that's what I would say in the near term you're going to see from Consumer.

Would you expect year-over-year margin improvement in Consumer?

In 2012? Yes.

Yes, versus 2011?

We're working on the game plan right now, but just as a Company, we expect margin improvement. Right now, we're -- we haven't finalized the plan, but I would tell you that our operating team, I don't think we'd come up here without a margin improvement next year.

All right. Thanks very much.

Thanks, Chuck.

Gentlemen, there are no further questions at this time. I'll now turn the floor back over to Bob Wells for closing comments.

We'd like to thank you all for your participation on the call is morning on this very busy reporting day for you. As always, I will be available over the balance of the day and week to take your follow-up questions. We appreciate you joining us this morning, and thanks for your continued interest in Sherwin-Williams.

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