宣偉 (SHW) 2012 Q2 法說會逐字稿

Good morning. Thank you for joining the Sherwin-Williams Company's review of the second-quarter 2012 financial results and expectations for the third quarter and full year. With this 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 Wednesday, August 8, 2012, at 5 p.m. 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 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 statements, 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 second-quarter results, we will open this discussion to questions. I will now turn the call over to Bob Wells.

Thanks, Claudia. Summarizing overall Company performance for the second quarter 2012 versus second-quarter 2011, consolidated net sales increased $218.3 million, or 9.3%, to $2.57 billion, due primarily to higher paint sales volumes in our Paint Stores Group and selling price increases across all segments.

Unfavorable currency translation rate changes decreased consolidated net sales 2.5%, and acquisitions added 1% to net sales in the quarter. Consolidated gross profit dollars increased $127.8 million for the quarter to $1.15 billion. Gross margin increased 130 basis points year over year to 44.7% of sales from 43.4% in the second quarter last year.

Selling, general and administrative expenses for the quarter increased 7.2% to $810.2 million. As a percent of sales, SG&A decreased to 31.5% in the second quarter this year from 32.1% last year.

Interest expense for the quarter was $10.2 million, a decrease of $1.5 million compared to second quarter last year. Other general expense net increased $3.8 million year over year, due primarily to higher environmental expense.

Consolidated profit before taxes in the quarter increased $70.8 million, or 27.5%, to $327.8 million. Our effective tax rate in the second quarter this year was 30.5%, compared to 30.3% in the second quarter of 2011. For the full year 2012, we expect our effective tax rate to be in the low-30% range compared to last year's rate of 40.4%.

Consolidated net income increased $48.7 million, or 27.2%, to $227.8 million. Net income as a percent of sales was 8.9% compared to 7.6% in the second quarter last year.

Diluted net income per common share for the quarter increased 30.7% to $2.17 per share from $1.66 per share in 2011.

Looking at our results by operating segment, Paint Stores Group sales in the second quarter increased 14.6% to $1.49 billion. Comparable store sales, or sales by stores open more than 12 calendar months, increased 13.9%.

Regionally in the second quarter, our Midwestern division led all divisions, followed by Southwestern division, Southeastern division and Eastern division. Sales by all four Paint Stores divisions rose double-digits in the second quarter compared to last year.

Paint Stores Group segment profits for the quarter increased $60.4 million, or 29.2%, to $267 million. And segment margins in the quarter increased to 17.9% from 15.9% last year.

Turning to our Consumer Group -- sales in the second quarter increased 5.9% to $397.7 million. Acquisitions increased Consumer segment sales 1.5% in the quarter. Segment profits for Consumer Group increased $19.4 million, or 31.6%, to $80.8 million in the quarter. Segment profit as a percent of external sales increased to 20.3% from 16.3% in the same period last year.

For our Global Finishes Group, second-quarter sales in US dollars increased 3.3% to $498.7 million. Acquisitions increased net sales in US dollars by approximately 3.8%, while unfavorable currency translations decreased sales by 5.4%. Segment profit in US dollars increased 58.8% in the quarter to $48 million. Acquisitions increased segment profits approximately $600,000 in the quarter, and unfavorable currency translation rate changes decreased segment profit $4.4 million.

As a percent to net external sales, Global Finishes Group segment profit was 9.6% in the quarter, compared to 6.3% last year.

For our Latin America Coatings Group, second-quarter net sales in US dollars decreased 4.5% to $187.3 million. Unfavorable currency translation rate changes decreased net sales by 14.5% in the quarter. Stated in US dollars, segment profits decreased $9.3 million in the quarter from $15.8 million last year. Unfavorable currency translation rate changes decreased segment profit $2.6 million. As a percent of net sales, segment operating profit was 5% in the quarter, compared to 8.1% in second-quarter 2011.

I'll conclude my remarks on the quarter with a brief update on the status of our lead pigment litigation. The Santa Clara case, involving claims and public nuisance brought by 10 cities and counties in California against five defendant companies continues to move forward. At a pretrial hearing held in May, the judge presiding over the case moved the trial date from September of this year to March 11, 2013, to allow the parties more time to complete the discovery process and file dispositive pretrial motions.

That concludes our review of the results for the second quarter of 2012. So I'll turn the call over to Chris Connor, who will make some general comments and highlight our expectations for the third quarter and full year.

Chris?

Thank you, Bob. Good morning, everybody. Thanks for joining us today. With a very solid first half of 2012 now on the books, we feel very good about our prospects for the full year. Although we faced some tougher comparisons in the second half, and particularly in the fourth quarter, we're confident that we can continue to outpace the market in both revenue and volume growth, and maintain the strong operating momentum we've established in the first half.

Whether you look at our results for the quarter or for six months, the operating leverage on incremental sales volume is pretty easy to spot. In the quarter, we grew net income 27%, and earnings per share 31%, on a 9% sales gain. Flow-through on the incremental sales of our four reportable segments combined topped 41% in the second quarter, and 32% in the first half. We controlled our SG&A spending; we managed working capital well; and generated strong six-month net operating cash.

The strength in our second quarter results came primarily from the North American market. We often have referred to the specific end market segments that we serve in our Paint Stores Group. In the second quarter, sales to the new residential painting contractor; the residential repaint contractor; property management; commercial contractors; DIY customers; protective and marine contractors; and product finishes all grew double-digits, led by both the new Residential and Residential Repaint segments, which were up double-digits in gallon volumes as well.

Our Consumer Group delivered solid growth across all of major brand and product categories -- our automotive finishes, product finishes, and protective and marine coatings businesses in North America were strong across the board. Even as the domestic economy showed signs of slowing in the second quarter, demand for our products held up well, and our pricing remains firm. Over the past few months, we've seen the price of high-grade chloride titanium dioxide stabilize due to weak industry demand. And we believe this trend is likely to continue over the balance of 2012.

This factor, combined with a fairly sharp drop in the price of propylene -- a key feedstock for monomers, latex, solvents and containers -- should help to curb the rate of raw material inflation going forward. Based on these developments, we now expect average year-over-year raw material cost inflation for the paint and coatings industry to be in the mid- to high-single-digit range in 2012, down from our previous guidance of high-single to low-double digits.

The significant jump in our consolidated gross margin in the quarter was the result of two factors -- first, the increasing production volume; and second, an adjustment in our second quarter LIFO accrual, consistent with our long-standing LIFO accounting practices, reflect our revised outlook for raw material inflation. Because these factors can cause distortions in our gross margin from quarter to quarter, comparing our year-to-date gross margin of 43.8% to last year's 43.2% -- an improvement of 60 basis points -- is a better representation of the progress that we've made in offsetting persistent raw material inflation.

In the first six months of 2012, we generated $202 million in net operating cash, an increase of $94 million over the first half of 2011. Cash from operations actually increased $153 million to $261 million, before payment of $59 million to the IRS in the first quarter to complete our 2011 tax settlement.

Our working capital, which we've described as receivables plus inventory minus payables, decreased as a percent of sales to 12.6% from 14.9% in the second quarter last year. The change in working capital increased net operating cash by approximately $71 million. We continue to use the Company's cash to purchase shares of our stock for treasury, increase our cash dividend, and expand our controlled distribution platform.

During the quarter, we acquired 1.5 million shares of the Company stock for treasury, bringing our total year-to-date purchase activity to 3.3 million shares at an average cost of $109.89 per share, for a total investment of $363 million.

On June 30, we had remaining authorization to acquire 17.75 million shares. Yesterday, our Board of Directors approved a quarterly dividend of $0.39 per share, up from $0.365 per share last year. Our store growth over the past four years, combined with innovative new products, marketing programs and sales initiatives, have resulted in steady market share gains in most contractor segments, and double-digit growth in DIY sales in six of the past eight quarters.

So far this year, our Paint Stores Group has added 20 net new stores, 15 of which were opened in the second quarter. This brings our total store count in the US, Canada and the Caribbean to 3470 locations, compared to 3408 a year ago. As we commented in April, we are ramping up our new store opening activity, and our Paint Stores Group plans to add approximately 60 to 65 net new store locations during the year.

Looking ahead, the outlook for global economic growth has become increasingly gloomy, and risks to the US economy have increased accordingly. Thus far, paint and coatings demand in our domestic businesses has remained resilient. We are optimistic that domestic architectural paint market volumes, primarily in the residential segment, will remain positive over the balance of the painting season; and demand for most industrial coatings will continue to expand. The greatest challenges in the second half are likely to be the worsening market conditions in Latin America and Europe, and the increasingly difficult comparisons from the second half of 2011.

Our outlook for the third quarter of 2012 is for consolidated net sales to increase in the mid-single-digits compared to last year's third quarter. With sales at this level, we expect diluted net income per common share for the quarter to be in the range of $2.05 to $2.20 per share, compared to $1.71 per share in 2011.

For the full year 2011 (sic), we expect consolidated net sales to increase in the high-single-digits to low teens over last year. With annual sales at that level, we've raised our expectations for diluted net income per common share for 2012 to be in the range of $6.20 to $6.40 per share compared to $4.14 per share earned in 2011.

Again, let me thank all of you for joining us this morning. And now, we'd be happy to take your questions.

(Operator Instructions). John McNulty, Credit Suisse.

Good morning. Congratulations on a good quarter. Looking at the Paint Stores segment, when we look at the growth, the 14.5% looks pretty solid. It's down from the levels that you saw in the first quarter. And I guess I'm wondering what the drivers are. Is it all weather, that we had talked about last quarter a lot; or are there other things going on, whether it's pricing decelerating or actual core growth decelerating? How should we think about that?

Yes, I think you should think about it, John, as a heck of a strong quarter for the Paint Stores Group -- 14% consolidated sales. When we look at some of the competitive numbers that are coming out, it's terrific. We commented that the first quarter is the smallest quarter for the year; we did have unusually good weather. We said we didn't think we'd pulled much demand forward, and gave guidance that we'd see the strong, double-digit sales gains in the second quarter. And that's exactly what happened.

Okay, fair enough. Then just one follow-up, on the margin side. When we look -- the consumer segment, year over year, actually had a better improvement than the Paint Stores side; which I guess, to us, is a little bit counterintuitive, given who your customers are. So can you walk us through the dynamics of what may be driving that improvement, versus maybe a slightly smaller improvement on the Paint Stores side?

In effect, what Chris said; we had a great quarter. John, this is Sean Hennessy. And when you take a look at the gallons that we're going through -- the manufacturing, the logistics, the warehouse systems over there -- it was a nice quarter for the Consumer Group on their own. But they also had some really nice improvement with the efficiencies of those gallons.

I will go back and just remind you, when we take a look at our Company, the gallons that we can put through that stores chain, that goes through that consumer chain, that's really -- when you look at that incremental margin that Chris mentioned in his comments -- that's really where we get it. So this is not uncommon. If you look at the margins three, four years ago, the peak margins of Consumers have always been higher than Stores. But what we said is, Consumers will be more stable.

Great, thanks a lot. Congratulations again.

Ivan Marcuse, KeyBanc Capital Markets.

Thanks for taking my questions. Good morning. In your same-store sales growth of 13.9%, how much of that was price, would you gauge?

Yes, we basically have given some directional color here. We said that volumes were more significant than price. Price was mid-single digits.

Got you. And then if you -- you mentioned on the economy showing some weakness. Did you see any sort of -- if you look at the quarter, month to month to month, did you see any sort of sequential slowdown? And then, if not, if it remained pretty steady, is there any reason to think that it wouldn't remain steady going into the third quarter, which is probably typically your strongest quarter?

I would say throughout the quarter, Ivan, performance is pretty steady, month to month to month. I think we're listening to some of the comments relative to more of the industrial sector of the US economy slowing down a little bit. But as we've commented, in the third quarter, we expected domestic, residential, architectural volumes to remain strong.

Great. And then my last question -- in raw materials for the quarter, where would you gauge them up on a year-over-year basis?

With the range of mid- to high-single-digits, Ivan, it's likely for the industry to run the raw material back up toward the upper end of that range for 2Q, just because of the annualization of inflation last year.

Great. Thank you for taking my questions.

Dennis McGill, Zelman & Associates.

Hi, and thank you. Just really quickly, Bob, on continuing that last question -- what would the exit rate be for the year, based on that guidance for the full year on the raw material inflation?

Probably below the low end of that range, in the fourth quarter.

Still positive though?

Yes. And obviously, Dennis, it depends on where they go from here. But based on the trends that we're seeing now, that we based our outlook of mid-to high-single-digits on, it's going to be mid-single-digits at worst in the fourth quarter, probably a little below that.

And then, Chris, your comment on incremental margins for the first half of the year being around, I think, 30% for the three segments combined, or four segments combined; for the full half, is there still a drag of price versus raw materials embedded in that?

Yes. I mean, the margin performance is behind last year's performance at that point. So there is absolutely a drag on raw, still.

Okay. And then there would also be a drag embedded in that from currency?

Definitely. Yes, on both sides.

The last question having to do with price, I think -- I had to run this quickly -- but price decelerated in Paint Stores 1Q to 2Q. Can you just clarify if that's true? And then I just have a follow-up on that.

Yes. I think when you take a look at it -- let me just answer, not so much from the first Q to second Q. When you take a look at the effectiveness -- let me just talk about the effectiveness of price increases over the years. With all we've said, and we were always realizing about 75%; and going into this raw material escalation, we continue to see more and more price increases and so forth. What we started to see is that effectiveness started going down from 75%.

I think it's pretty natural when you hear Chris's comments that comp store is up 13.9%, over half of that, was over -- was volume. That tells you that price, and the amount of price we put in, you multiply it out; you would say that anniversarying some of these things, we didn't get 75%. We also think we have probably have gotten the majority.

So, when you take a look at it, we did anniversary a price increase in June of last year; which, when you sit there and take a look at June, we did see -- that did have some effectiveness. And we started seeing the price difference a little bit lower in June versus the other two months, just as we annualized that price increase.

But that's how I would say it, because of that June anniversary. And I think in total, when you look at the kind of pricing we did get in the second quarter, it will also tell we didn't get 100% of the 75%.

Okay, that's very helpful. And then on top of that, with a new residential market, and construction coming back, and likely outgrowing overall volumes; and thinking about that over the next couple of years, is there a negative mix on price there, because it tends to be more boilerplate product?

I don't think so. We've commented that, sometimes, pricing for those larger customers will be a little bit softer. But, again, the operating margins are very consistent across all these customer segments. So that's not a concern for us at all, Dennis.

I think that that market has changed a little bit from the 80s, when it was more of a boil and go, I think, as you see them.

Higher-quality products are being sold into that segment.

So the price per gallon in new construction is not that different than what you might see in other segments?

Slightly less, but not that dramatic.

Okay, great. Thanks, guys.

PJ Juvekar, Citigroup.

Yes, hi, good morning. So the contractor's strength that you saw at least in the early spring, has that continued here late in the season? And do you expect the contractor market to outperform DIY in the second half?

Yes. We took you through was kind of a litany, PJ, of the specific contractors segments inside that broad category that we monitor. And the comment that all -- every one of those segments was up double-digits in the quarter; and, again, as we've commented throughout the year, this will be the strength for the Company this year. We continue to have lots of projects on the books. And we're expecting to have good performance from that group in the third and fourth quarter.

Great. And in Global Finishes, your margins have jumped up nicely, despite some negative FX impact. Are these margins sustainable given, Chris, your gloomy outlook that you described?

We think -- what this is Sean, by the way -- PJ, but we think the margins show in a couple of things. I think in Chris's comments he talked about domestic sales inside that global finishes group are strong. And we get more flow-through on domestic sales than we do outside the country. So I think that shouldn't change. I think it's consistent with what Chris said.

And also, I think the operating margins are starting to be improved, as we're starting to see some integration activity start to show some positive results.

And finally, with raw materials taming down, what kind of pricing do you expect in the second half?

Well, I think we've indicated we publicly shared with you when we raised prices. February was the last time that we've taken prices. We don't comment prospectively on forward price increases. We made the comments that our prices held firm in the second quarter. Time will tell.

Great, thank you.

Jeff Zekauskas, JPMorgan.

Hi, good morning. So your consolidated sales grew a little bit more than 9% in the quarter, and you expect mid-single digits in the third quarter. Is the difference between the two growth rates the Latin American Coatings Group and the Global Finishes Group, essentially -- that is, slower growth there?

Yes, and we expect that what we have seen throughout the year -- if you look at the euro; and, really, the Brazilian real; and you look at the Mexican peso versus last year -- and what we originally thought the convert -- foreign currency is going to be. The headwind is growing, Jeff. And so when you sit there and take a look at it, that's part of the biggest piece of the issue. And the other thing is, in Bob's comments, is take a look at the third or fourth quarter a little stronger for us. And this is when we started seeing this strength last year. So we're going up against a little tougher comps, but foreign-exchange headwinds, definitely, the bigger difference between the second and third quarter.

Okay. And for the six months, your reported administrative costs are up about $42 million or $43 million. For the year, are they going to be flat, or up $42 million or $43 million. Do you have some rough estimate?

Yes, I think when you take a look at -- that growth really came from incentive comp; continuing doing some work on environmental issues; as well as, we've done a lot of work on what I'll call IT projects. And I think those things will continue to go through. But I think when you take a look at that $40 million increase year over year, I would guess that we would not run at that rate in the second half. And it would probably be half of that in the second half.

Right. Okay. And then lastly, Chris was talking about stability in the TiO2 market, and I always get muddled over that. That is, are TiO2 prices stabilizing in July, versus where they were in April? Or did they stabilize in April where they were in December? Or what's the stability?

What we mean by stability, Jeff -- this is Bob -- what we mean by stability is that pricing is no longer -- it does not appear to be rising. We do not believe that the price increase announced by the industry, effective in July, was very successful. So it appears that TiO2 pricing has stabilized. We do not believe that they are tracking down.

And then lastly, the LIFO accrual change in the quarter, how much did that benefit gross margin or operating profits -- or whatever measure, just the effective -- the change in the accrual?

Right. The change in the accrual is probably around 0.4.

0.4?

Yes, 40 basis points of our margin.

The core margin was approximately 44.3%. And then you had some LIFO adjustments from the first quarter that reversed in the second quarter.

Okay, good. Thank you very much.

Chuck Cerankosky, Northcoast Research.

Good morning, guys. This is Jamie Dunford on for Chuck. What are some of the changes you guys have seen that has given you the confidence to increase the guidance for this year?

Well, I think as we've said all along, Jamie, that as we get into the year and have a little better visibility towards the end is when we are able to give you a better look. And as we've commented, it's been a strong gallon performance for the Company. And you should read into the guidance for the remainder of the year, our confidence that we're going to continue to see that kind of gallon growth; again, driven by North American residential, architectural paint gallons.

All right. Thank you very much.

Duffy Fischer, Barclays Capital.

Yes, good morning. Can you talk about the gap between pricing and stores in the big box, and how has that changed over the last one year?

Yes, Duffy, we pay attention to that. I think you've seen price -- stock price increases across the board, both at the big-box channel as well as the hardware channel, specialty stores, et cetera. We've long commented about the irrational industry that we operate in. Titanium dioxide, raw material cost pressures, impacts all manufacturers and suppliers. And as a result, pricing eventually winds its way into the marketplace.

We're comfortable with the gap; there is a reason that certain consumers choose to shop in a specialty store environment. And as a reminder, painting contractors buy at a significant discount off of that shelf price. So the gap diminishes quite substantially, if any gaps at all exist, when you get to that customer segment.

Fair enough. And then just to clarify, with your assumptions for price and your assumptions for cost, what should we think about for that incremental volume going forward, from volume? So that incremental dollar of sales that's from a volume basis, what's the incremental margin that you guys will realize?

A lot of times we get -- we really point to -- if you look back at the incremental margins that we were realizing in 2002 to 2007 time frame, we felt that incremental gallons, this time, would be stronger than they were in that timeframe. So the numbers that Chris said, we are feeling pretty good about. I think that as long as we continue to get those kind of gallons, I think you're going to see flow-through.

Okay, great. Thank you.

Ghansham Panjabi, Robert W. Baird.

Hey guys, good morning. Chris, on the inter-quarter trends that you articulated, were those trends pretty consistent month-to-month for the Global Finishes and Latin America businesses, also?

Yes, it was a steady quarter across the board. All three months, we were looking at pretty much the same difference. We had some day count changes from month to month, which impacts a retailer like us, but for the most part very steady.

So your caution, better said, is more a function of what you read about in the news, et cetera, versus what you're necessarily seeing, right?

Correct.

And then, within Global Finishes, just given the strength in the margins -- I'm sorry if I missed this -- but can you parse that volume by the various constituents in there -- auto, refinished, protective, et cetera?

Yes. Ghansham, we don't really break out volumes like that. We give you that information on our stores business directionally, but not for the other segments. I think it's -- suffice it to say that the kind of pricing activity this Company has taken has been fairly consistent across these boards. There were definitely volume gains in each of those areas.

Okay, and then just finally on working capital; obviously, a terrific job there; and inventories are below year over year, even with the surge in sales you've had. Is this the new run rate, in terms of working capital? Or do you think there's more to go here?

Yes. I think when we take a look at our working capital, last year we finished right around just below 11% as a percent of sales. We think we're in pretty good shape. One of the things I want to remind you is, last year we did take a little more inventory into the third quarter from the second quarter, because of possible shortages in -- a lot of raw material discussion. If you remember the -- last year, Consumer Group, actually, we started to see that inventory drop in the third quarter last year. And we actually had some (inaudible) when that inventory drops, that's when you start to see some flow-through. So Consumer had good flow-through in the quarter than we said. This year was going to be more of a normalized nature. And so when you take a look at it, I think our working capital is in pretty good shape. But I think 11%, or just short of 11% for the full year, I think is a pretty good number.

Okay, great, thanks so much.

John Roberts, Buckingham Research.

Good morning, guys. The drought that we've had across much of the US -- not good for the crops, but probably pretty good for exterior painting. Did you see much higher growth in exterior versus interior?

No. This is the time of year that we should be seeing our exterior gallons perform; they are. They're in line. There's nothing unusual there. The dry weather is good for painting; but 100-degree days, not so much. We lose the mid part of the day; painters are starting a lot earlier. Guys are waiting at the front door when we get them open at six in the morning.

Okay. And then, secondly, have you seen the lower propylene prices actually flow through in resin and polypropylene containers and so forth? Or is that still just your anticipation of that?

I think the propylene-based commodities, John, in the second quarter, were probably down slightly. I think there may be more benefits to go.

Thank you.

Don Carson, Susquehanna Financial.

Thank you. Chris, just wanted to get back to your view on the overall markets. What's your assumptions for how much US architectural volumes will grow overall this year? And, again, what percentage would be contractor versus big box? And then, within contractor, it seems that you're growing share. I know some of your competitors, like Ben Moore and [Axis], continue to have well-publicized problems; just wondering how that's benefiting you?

Yes, I think, Don, we've talked about the industry data points. And a lot of smart people, like you and your colleagues on the phone, have talked about the architectural gallon market in the United States growing perhaps at a 3%, 4% rate, which would be more than double its normalized run rate. So that kind of gives you a sense; that feels about right.

We've shared with you, directionally, the kind of gallon performance that we are having on top of that. So we think we're gaining share. We have commented that the contractor is rebounding and reverting back to about 60%. Our expectation of the total purchases of architectural coatings in America -- we're probably a year or two away from them getting back to that level. So they're growing a little bit faster. The market is growing a little faster, and we're just in the sweet spot and catching it.

And on the gross margin, the comps get a lot easier in the second half; and, of course, now, raws aren't going up as much. So are you looking now for much bigger improvement in second-half gross margins than you were, say, back in at your May 23 meeting?

Well, we always looked at that [41.80] in the third quarter, and thought that we were going to be able to beat that, that was for sure. We expect that the second half margins -- when you look at versuslast year's second-half margins -- we feel a little more bullish than we did back on the 23rd, you're right.

And did you change any of your production plans accordingly, given that you see raws coming down, in some cases, in the second half? Does that mean you came into the third quarter with less inventory than you might have otherwise?

Yes, I think when you take a look at that question that was asked earlier, and you see the raw materials sent and the production down, I think we definitely have less inventory than we did a year ago. Last year we were in a position -- we thought that the raws would continue to rise. And this year we felt it was a little more prudent not to have as much inventory.

Thank you.

Dmitry Silversteyn, Longbow Research.

Good morning. I want to understand a couple of dynamics that you're seeing here. The expansion margins on the global side of the business, you talked about some integration costs setting. I'm assuming it's from the European acquisitions that you have done a couple of years ago. What's going on in the that market? And am I right in assuming that was the major driver behind the margin improvements that you're seeing in Global or is there some other benefit that's going on there?

I think the number-one was the domestic sales in the Global Finishes Group. We do still have quite a bit of sales inside United States and Canada. And when you look at the domestic sales, that by far was the number-one reason for the margin improvement. But on top of that, there was some improvement on the European operations. And you're right, it's those acquisitions we did a few years ago.

Would it be fair to say, then, that the margin impact was driven more by mix, as faster-growing, higher-margin North American business versus perhaps flattish margins -- or flattish volumes in Europe, which is a lower-margin business?

Yes.

That's fine. Secondly, your administrative costs continue to be up, year over year. That's flat sequentially, so I'm assuming that's sort of the new run rate that we should be looking at, in terms of operating profitability?

Yes. And as I said, I don't think that we will be up $40 million like we were in the first half of the year. But I think, when you take a look at that last year; last year our admin was around $243 million, give and take. I think if you are -- the run rate will be in that $290 million to $310 million.

Got it. That's helpful. And then, finally, just curious about your comments on that TiO2 outlook. You talked about pricing being flattish on weak demand. Paint is the number-one source of TiO2 demand. And the paint market, at least in North America, seems to be doing well. So is it the weakness in international markets that's leading to declining demand for TiO2?

That's correct; and it's primarily Asia-Pacific.

Okay, got it. All right, that's all the questions I had. Thank you.

Eric Bosshard, Cleveland Research Company.

Good morning. A couple of things -- the gross margin; I understand, looking at the first half in total, the pull out the LIFO benefit. Should the second half gross margin expansion be materially greater than the first half?

We'll wait and see. I don't want to put some guidance out there that we're going to have to live with, Eric. We're pretty careful. Usually, we'd like to give you pretty good guidance after the second quarter. But we'll wait to see what happens with the raws here in the next couple of months. And then, I think, we'll see. But there's a lot of different moving parts right now with the volatility in the raw materials, quite honestly. I don't want to put an adjective on it, like you did.

I understand that. Secondly, in terms of price, the change from 2Q to 1Q, I guess if you could just clarify a little further. It sounded like price in 1Q contributed maybe as much as nine or 10 points, and 2Q closer to five. Is that right? And should the second half be sustained in this five? Or how should we think about that? And if you could give us any more color on what's going on within that.

Yes. I think when you take a look at the way prices moved up last year, I think the numbers you have are in the ballpark, pretty good. I think that we'll see what happens with price. But we don't see price growing from that second-quarter number, that's for sure.

And is that just -- I guess, importantly -- is that just cycling off? Or is there -- are you taking a little more aggressive position on price that's accelerating your share progress?

It's cycling off. I think we're going to -- just like I mentioned, the cycling off is a June 6 price increase from 2011. We've got a couple -- I think it's October -- we're going to see another cycling off. We don't see the price metrics changing in architectural paint market, it is just that annualization.

And then the comments on the opening part of the call, Eric, about prices holding firm; that's our expectation. So it's always, as Sean commented, we're just coming up against these robust and consistent price increases we had in the past years.

And then the last question, in terms of volume, which sounds like it was a very good number this quarter, again. Is that the rate at which volumes should grow? I'm just trying to understand the sales guidance for the second half of the year, full-years. Is the second quarter volume growth that you saw, is that what you expect to be sustained in the back half?

I think when you take a look at it because of the strength of the volume is starting to go against harder comps. I think if we seek volume slightly below where we were in the second quarter, but not materially lower.

And then negative volumes, first half of last year; positive volumes, second half of last year. The kind of run rate that we're on right now feels consistent to us. We just have that tougher comparison.

And then, just last one if I might -- second-quarter sales guidance, I think, was 10 to 15 and you reported roughly 10 or 9.5. Was the difference there currency or international growth? Can you talk about the disparity or the difference between those two?

Yes, FX was 100%. The Brazilian reais went down -- it went to 210. And the Mexican peso, the euro all three of those, I would say, it is 99% of where we -- the difference between our guidance and the 9.3 that we came in at.

Great, thank you.

Matt McGinley, ISI Group.

Good morning. I have a follow-up on the LIFO comment that you made; I know in the 10-K, you disclosed that LIFO is an impact of about $0.59 during all of 2011. I think it you said it was 40 basis points of help that you got from that in the second quarter. So I think there's still a lot left in terms of how you recover that. Is there a particular quarter within the year where you had a bigger impact, or was that relatively spread out over the entire year?

In 2011?

Correct.

Yes, I think the one -- it was really the third quarter and last year. And you saw the third quarter go down to 41.8 last year. It was a little heavier than the other three. And that's because as the raw materials continue to rise and the basket continued to rise, and we were trying to catch up. And this year it looks -- and we are seeing that the basket forecasted that we're giving you continues to go down.

Okay. So, all else equal, you would expect that the third could be the quarter of greatest recovery within the year?

Yes. I think that the year-over-year comparison of gross margin -- we're going to see the greatest impact of that in the third quarter.

And then on your third-quarter sales guidance, you said that the waning impacts of pricing will not be the benefit it was for the past handful of quarters. You said that FX would likely be worse. Implicit with your guidance, are you saying that the units will be positive? Or would you expect that be to be down in the third quarter?

Units will be positive.

For the Company in total, not just the Paint Stores Group?

Absolutely.

Okay, thank you.

Bob Koort, Goldman Sachs.

Thank you, good morning. Sean, I think I mentioned you guys had drawn down a little bit on your inventories. I think maybe you are referring to raw material inventories. So I'm just curious, what's your expectation as you go through the second half? Is there still some room to do that? Or, certainly on the TiO2 side, we've seen your supplier base has had some challenges here in the last few months. Have you reached a sort of detente there? Or what's your expectation going into the second half?

I think our raw material inventory will be slightly lower; maybe 5% lower at the end of the year than we are right now. But I do think finished goods will also go down, just as they always do, seasonally, in the third and fourth quarter, because our production goes down.

It's interesting. It sounds like there's a bifurcated market. You had mentioned that, in the US, architectural paint demand has been very good. And you commented that it should continue to do so. Yet the TiO2 weakness seems to be more Asian-based. Do you expect that you will see some change in behavior from your suppliers, now that that TiO2 market has loosened up? Or is it still going to be the same old fight that you usually confront?

You're articulating diverging market trends -- softness globally, but a strength in the US. Don't forget that when titanium prices have been running on us the past couple of years, it's been also a diverging trend because they were referencing tighter demand when we were seeing collapse in the US architectural market. It's not for us to articulate what their behavior will be like going forward. We can only report on past trends of buying these raw materials. When global supply slackens, it's a period of time when they lack to go to get pricing. And that's what Bob commented on, that it's the July price increase that was announced did not go [in]. And we'll see how the second half unfolds.

And just as a reminder, Bob, the North American market consumes less than 25% of global supply of TiO2. So we've got 75%, more than 75%, of the global TiO2 market that's struggling for volume, even if North America is relatively strong.

That's helpful. And lastly, if I might, can you give me a sense -- if I read in some trade rag that propylene price, contract price, changed today, how long would it be before it actually shows up in any meaningful way on cost-of-goods line for Sherwin-Williams?

Typically, about 60 to 90 days.

Thanks so much.

Kevin McCarthy, Bank of America.

Hi, guys. This is Chris Perrella on for Kevin. Could you elaborate on the softening that you're seeing down in Latin America, for the regional -- whether it's a particular region or end markets down there?

Yes. I think to put that in perspective, we're still seeing volume gains in our Latin American operations. First and foremost, the segment reporting is impacted by the FX that Sean is taking you through now. So that's a lot of the headwind. There is a general softening in the Brazilian economy that you read about, and we feel that. Same is true, slightly, in Mexico. But beyond that, these businesses are performing well; holding their own; gaining share, in some cases; and generating volume gains.

And pricing gains, as well, in the region?

Yes. Again, back to the global rational nature of this industry, and the important need to get pricing after raws; and so we have seen pricing throughout the region, over the last couple of years -- including the beginning half of this year -- consistent with the kind of comments we've been making about North America.

Okay, and the Geocel acquisition, does that account for the growth in the -- or the sales contribution in the consumer segment?

Yes, it will be reported in the consumer segment. There was one month of -- yes, so it was -- it was not the majority of the sales growth, by any stretch of the imagination.

Okay, thank you very much.

Aram Rubinson, Nomura Securities.

Thanks for taking my question. Question about innovation and what it means for price -- it sounded, at least from the Analyst Day, that innovation is at its highest level in many years. And I would think that usually helps to sustain price. Just wondering why, given that circumstance, why we'd be getting less than a 75% realization? And I'm also wondering how that change manifests itself; if it's pushback from contractors on price? If it's promotions for retail or something else? And is there something we could be doing to get back to that realization?

Well innovation, I think, is an important part of it. But it speaks to the products that are introduced, not the core product line. As we commented on our Investor Day, this has been a particularly robust year for us with new products; I think, somewhere around 30 new products have hit the market. To your point, Aram, our intent is to bring those products out more at the higher end of the performance spectrum. So they are setting higher selling prices, better margins. But the vast majority of products that we sell -- it's the Company, year in and year out, despite a strong year like this -- come from the core products, the real workhorse products that painters use day in and day out. And that's where I think Sean made the comment about going out for pricing, and not really have the having the full 75% implemented just yet.

And I think if you take a look at the history, back in the 80s when we used to go out once a year; that's 75%. The first time we tried to get a second price increase in the first -- two in one year, we didn't get all 75%. All of a sudden, we got pretty good, unfortunately -- we put two in a year; then we went to three. And I think we had somewhere in the neighborhood of seven price increases in about 35 months. It was so rapid, I think that it was hard -- we were halfway through it, I think -- that's really what happened to us. Not that I think the market has changed.

And two quick things -- can you tell how much FX is in Q3 guidance? And, also, the last time you gave us gross profit dollar change by segment. Would you mind doing that for us again?

When I did that last time, we had the Q completely written. We're not in that same spot. We're going to release the Q on July 25. So I think we're not going to be back on with you between then and then. But then I think you get the dollar changes right then and there from the Q. But no, I think that FX, if you take a look at how much headwind we had in the second quarter, I think you can -- the guidance has more FX headwinds than in the second quarter. I really don't want to give you an exact number.

All right, thanks, guys. Good luck.

Nils Wallin, CLSA.

Good morning, and thanks for taking my questions. On the Latin American group, it looked like FX hurt your top line close to $30 million. And yet, on the operating profit level, it was only about a $2.6 million hit. So could you explain what you did to mitigate that, following all the way to the bottom line? Was it improved leverage -- fixed cost leverage from higher volumes? Or just add a little bit more color to what you did to mitigate that headwind.

I think one of the things you have to realize is, when you do get FX headwinds, it's not dollar-for-dollar going to the bottom line. Because it also affects your SG&A and it affects other things. So when you take a look at it -- and I think Chris has hinted that we did have volume gains down there; and the world market on the raw materials pricing was going on in there. I think volume offset it. I think pricing offset it. And those are, really, the two things.

Okay, thanks. On your guidance for the full year, it suggests some deceleration in the back half, in terms of earnings growth. Is there anything behind that? Is it conservatism? Is it seasonality? Or is it just the first half has been so strong?

I think the first half, when you sit there and say, is this first-half -- you know, if you get a chance to read the Q, there's a lot of things in there over the last 12 months. Really, when you look at the last four quarters combined, our net operating cash was over 10%. The flow-through was very strong, when you put these four quarters together. It's going up against a little tougher comparisons. But when we look at the second half, we're pretty excited about how things are going to come out. We think that we're going to have some nice flow-through.

Great. And then just, finally, it seems like in the Paint Stores Group, the remodel part of the portfolio is probably driving a little bit more of the volume than the new residential. I don't know if that's completely accurate, so if you could help me with that. As we see home sales improve, existing home sales, whatever's going on there, are we going to -- do you think it will be a mix shift? Or are we going to see that residential growth -- the remodel growth stay where it is, and then on top of that, have a nice icing on the cake from new residential?

Yes, I think that's a good way to think about it, Nils. As a reminder, the demand for architectural paint in North America is predominantly for remodel, redecorating, maintenance. So you can think in terms of 80%, plus or minus a few points on that. As the new construction comes back, it will have a positive impact, but a smaller amount. I think most folks are talking about housing starts somewhere in the 700,000 range. We believe that the sustainable number in our country is north of 1 million units. So we have several years of reasonable marginal growth and improvement in that to get back to a normalized run rate.

On our way there, our expectations will be that the ongoing maintenance -- decorating for the existing infrastructure and housing stock -- will be really driving this number. And to your point about as housing sales are picking back up, as housing volumes are improving, those are all really positive market metrics for sustained growth in this business.

Thanks very much.

Dmitry Silversteyn, Longbow Research.

Yes, I've just got a quick clarification. You talked about the Painting group seeing about mid-single-digit pricing on a year-over-year basis. I'm assuming it's somewhat similar in the Consumer Group, which would imply that the volume growth there was pretty close to zero, year-over-year. Can you talk a little bit about what's driving that, if my math is correct?

Well, as we have stated over and over, we don't give that kind of same clarity and breakout that we do in our Stores business for the other segments. But I will tell you that our Consumer Group did have volume growth as well.

Okay. I'll leave it at that. Thank you.

Gentlemen, there are no further questions. I will now turn the floor back over to Bob Wells for closing remarks.

I'd like to thank you all, once again, for your participation in today's call. I will be available, as usual, over the balance of the day and week to address any follow-up questions. We appreciate you joining us today, and thanks for your continued interest in Sherwin-Williams.

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