宣偉 (SHW) 2016 Q2 法說會逐字稿

Good afternoon. Thank you for joining the Sherwin-Williams Company's review of the second-quarter results for 2016. With us on today's call are John Morikis, President and CEO; Sean Hennessy, CFO; Allen Mistysyn, Senior Vice President, Corporate Controller; and Bob Wells, Senior Vice President, Corporate Communications.

This conference call is being webcast simultaneously in listen-only mode by Issuer Direct via the Internet at Sherwin.com. An archived replay of this webcast will be available at Sherwin.com beginning approximately two hours after this conference call concludes and will be available to Wednesday, August 10, 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 statements speak only as of the day 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.

(Operator Instructions). I will now turn the call over to Bob Wells.

Thanks, Jesse. Good morning, everyone, and thanks for joining us. In the interest of time, we've provided some balance sheet items and other selected financial information on our website, Sherwin.com, under Investor Relations, July 21 Press Release. I'll begin by highlighting overall Company performance for the second quarter 2016, compared to the second quarter 2015, then comment on each reportable segment.

Consolidated net sales increased 2.8% to a record $3.22 billion, driven by higher paint sales volumes in our Paint Stores Group. Unfavorable currency translation decreased consolidated net sales 1.5% in the quarter. Consolidated gross profit dollars increased $105.8 million in the quarter to $1.64 billion.

Our consolidated gross margin increased 200 basis points in the quarter to 50.8% of sales, from 48.8% in the second quarter last year. More than half of the gross margin improvement in the quarter resulted from the positive mix effect of Paint Stores Group, our highest gross margin segment, outpacing the growth of the other segments, coupled with increased operating leverage from higher production and distribution volume.

Selling, general, and administrative expenses increased $54.7 million over second quarter last year, to $1.1 billion. As a percent of sales, SG&A increased to 32.7% in the second quarter this year, from 31.9% last year. A relatively small portion of this increase was acquisition-related expenses.

Interest expense increased $28 million compared to second quarter last year, to $40.9 million. This increase includes $20.7 million in acquisition-related interest expense, with the balance resulting from a shift to long-term debt from short-term that occurred midyear 2015.

Consolidated profit before taxes in the quarter increased $31.4 million to $539.2 million, due primarily to improved operating results from our Paint Stores Group. Unfavorable currency translation reduced profits before tax in the quarter by $3.3 million compared to second quarter last year. Our effective tax rate in the second quarter was 32.1%, excluding the impact of the change in accounting standards. For the full year 2016, we expect our effective tax rate will remain in the low 30%s, excluding the impact of the change in accounting standard.

Consolidated net income increased $28.1 million to $378.1 million. Net income as a percent of sales was 11.7%, compared to 11.2% in the second quarter last year. Diluted net income per common share for the quarter increased 7.8% to $3.99 per share, from $3.70 per share in 2015. The $3.99 includes $0.09 accretion from the accounting change and $0.16 dilution from acquisition-related expenses.

Looking at our results by operating segment, sales for our Paint Stores Group in the second quarter 2016 increased 6.2% to $2.11 billion, from $1.98 billion last year. Comparable store sales, that is sales by stores open more than 12 calendar months, increased 5.2%.

All of the Paint Stores Group sales increase was due to higher organic architectural paint and equipment sales volumes across all end markets. Price mix had a negligible impact on sales in the quarter and protective and marine coating sales were a modest drag on revenue growth.

Regionally in the second quarter, our Southeastern Division led all divisions, followed by Midwestern Division, Southwestern Division, Canada, and Eastern Division. Sales and volumes were positive in every geographic division.

Segment profit for the group increased $75.6 million, or 17.4%, to $509 million in the quarter, as higher architectural paint and equipment sales volumes were partially offset by higher SG&A spending. Segment operating margin increased to 24.1% of sales, from 21.8% in the second quarter last year.

For our Latin America Coatings Group, second-quarter net sales stated in US dollars decreased 11.2% to $133.3 million, due to unfavorable currency translation and negative volumes that were partially offset by selling price increases. Currency translation rate changes decreased sales in US dollars by 16.4% in the quarter.

Segment profits in US dollars decreased to a loss of $9.6 million in the quarter from a profit of $4 million last year. Segment profit was negatively impacted by higher raw material costs and unfavorable currency translation that were partially offset by selling price increases. Currency translation decreased Latin America segment profit $1.3 million in the quarter. As a percent of net sales, segment operating profit was negative 7.2% in the quarter, compared to a profit of 2.7% in the second quarter 2015.

Turning to the Consumer Group, second-quarter sales decreased 2.6% to $477.5 million. As a reminder, in April, we annualized the completion of the load in of the HGTV Home by Sherwin-Williams paint program in Lowe's stores which was completed by May 1 last year.

Segment profit for the Consumer Group decreased $6 million to $108.3 million in the quarter, from $114.2 million in the second quarter last year, due primarily to lower sales and increased SG&A spending, partially offset by improved operating efficiencies. Segment profit as a percent of external sales decreased to 22.7% from 23.3% in the same period last year.

For our Global Finishes Group, sales in US dollars decreased 1.3% to $499.2 million in the quarter, as unfavorable currency translation was partially offset by positive price mix. Unfavorable currency translation decreased net sales for the segment 2.6% in the quarter.

Second-quarter segment profit stated in US dollars increased $8 million, or 13.9%, to $65.2 million, due primarily to decreasing raw material costs and good cost control, partially offset by unfavorable currency translation, which decreased segment profit $1.5 million in the quarter. As a percent of sales, segment profit increased to 13.1%, from 11.3% in the same period last year.

That concludes my recap of our results for the quarter, so I will now turn the call over to John Morikis who will make some general comments and highlight our expectations for third quarter and full year.

Thank you, Bob. Good morning, everyone, and thank you for joining us. I think it's fair to say our results for the second quarter were mixed.

Architectural paint volumes through our Paint Stores Group held up well in the quarter, resulting in solid revenue growth and continued strong earnings leverage and flowthrough. Our Global Finishes Group also did a commendable job of managing both gross margins and SG&A, resulting in a respectable 180-basis-point operating margin improvement on modest volume growth.

We continued to see positive demand momentum in some of our industrial coatings businesses, primarily in Europe and the US. And currency headwinds in Latin America are starting to ease. Those were the positives in the quarter.

On the other hand, while we expected difficult comparisons in the HGTV Home Paint Program, due to heavy stocking orders in the second quarter last year, some of the retail programs we thought would generate growth in the quarter fell short. We are supporting many of these programs with incremental SG&A investment, and we have high return expectations on these investments. Finally, while currency comparisons have improved in many Latin American countries, demand trends remain difficult, and our outlook for this segment for the full year continues to deteriorate.

Our earnings-per-share results in the quarter include expenses related to the Valspar acquisition, as well as a tax benefit related to the adoption of a new accounting standard. If you backed out these items, diluted net income per common share increased 9.7% on sales growth of less than 3%. As a percent of sales, gross profit increased 200 basis points year over year, and operating profit and profit before tax both expanded a little more than 50 basis points.

Excluding the acquisition expense, our incremental margin on consolidated profit before tax was 36%. SG&A was the only line on the P&L that went the wrong way as a percent of sales, the result of higher SG&A spending by Paint Stores Group, channel investment by Consumer Group, and expenses related to the Valspar acquisition.

Paint Stores Group delivered another strong sales performance in the residential segment, which include residential repaint contractors, new residential construction, and DIY. Combined, sales to these three segments grew by more than 10%.

Sales to commercial, healthcare, and property management customers also generated solid year-over-year growth. The outlook for continued growth in these segments over the balance of the year remains positive, supported by very healthy order book trends reported by most of our contractor segments extending into 2017.

During the first half of the year, Paint Stores Group opened 45 new stores and closed 14 redundant locations. This completes our consolidation of redundant store locations acquired from Comex. Our plan for the full year still calls for store openings in the range of 90 to 100 net new locations. Today, our total store count in the US, Canada, and the Caribbean stands at 4,117, compared to 4,025 a year ago.

We anticipated a modest sales decline from Consumer Group coming into the second quarter. This, combined with the elevated SG&A investment, tempered our second-quarter outlook, which is reflected in our guidance.

We remain confident that the great work our Consumer Group teams are doing in strengthening our brand positioning across all retail channels and the investment we are making in many of these channels will pay handsome returns in the years ahead. Consumer Group's commercial, industrial, and MRO business continued to show good progress on both sales and margin in the quarter.

Unfavorable currency translation continues to weigh on sales and profit performance in our Global Finishes Group and Latin America Coatings Group. Both segments reported positive sales in local currency in the quarter, and Global Finishes Group volumes were positive, thanks in large part to improving market conditions in North America and Europe.

Volume sales in most Latin American countries continued to decline, with Brazil standing out as the most notable exception. Although Brazil's volume momentum improved in the quarter, margin pressure from raw materials continued to challenge profitability in Brazil and throughout the region.

In the first six months of 2016, we generated $510 million in net operating cash, an increase of $161 million compared to the first half of 2015, driven by higher six-month net income and good working capital discipline. Working capital was a use of cash in the quarter, increasing by about $3.8 million year over year. Working capital as a percent to sales decreased to 11.6%, from 11.8% at the end of the second quarter last year.

Our capital expenditures in the quarter totaled $62.1 million. Depreciation was $43.8 million, and amortization was $6.2 million. In 2016, we anticipate capital expenditures of approximately $240 million, depreciation of $170 million to $180 million, and amortization of about $30 million. Capital spending will run higher than normal in 2016 as we complete some facility renovation projects.

During the quarter, we made no open-market purchases of our common stock for treasury. On June 30, we had remaining Board authorization to acquire 11.65 million shares. As indicated when we announced the Valspar acquisition, we intend to build cash on our balance sheet over the course of the year to reduce total borrowings required to close the deal, which will eliminate our share repurchase activity in 2016.

At the close of the second quarter 2016, our cash balance was $402.7 million, compared to $75.1 million on June 30 2015. Yesterday, our Board of Directors approved a quarterly dividend of $0.84 per share, up 25% from $0.67 last year.

The outlook for Paint Stores Group over the next six months remains very positive, and we should see steady improvement from Consumer Group and Global Finishes Group. These positives will be offset to some degree by continued weakness in Latin America.

As we've commented over the past few quarters, the gross margin tailwind we have enjoyed in recent years from raw material cost deflation will diminish as we go through the back half of 2016. Our outlook for third quarter 2016 is for consolidated net sales to increase low to mid single digits percent compared to last year's third quarter. With sales at that level, we expect diluted net income per common share for the second quarter (Sic-see press release 3Q) to be in the range of $4.10 to $4.30 per share, compared to last year's record $3.97 per share.

The full-year 2016 earnings-per-share guidance we provided at the end of the first quarter did not include expenses related to the acquisition of Valspar or the tax benefit from the adoption of the new accounting standard. Today, we are revising our guidance for full-year consolidated net income per common share to reflect these two impacts.

For the full year, we expect consolidated net sales to increase over 2015 by a low single-digit percentage. Annual sales at that level, we are revising our expectation for full-year diluted net income per common share to be in the range of $11.65 to $11.85 per share, compared to $11.16 per share earned in 2015. Again, I would like to thank you for joining us this morning. And now, we'll be happy to take your questions.

Thank you. (Operator Instructions) Christopher Parkinson, Credit Suisse.

Perfect. Thank you very much. Can you just comment on your performance in the DIY channel, specifically at the home centers, and how HGTV trended versus Infinity inventories? And then also whether or not you believe there is a large inventory -- excuse me, a pull forward from March as well? Thank you.

I don't think that there was a large pull forward in the quarter -- in the first quarter. I'd say that our performance in the second quarter, we feel as though inside our largest customer with Lowe's that we're continuing to gain momentum. As far as the performance in the market, I think we're going to let them comment on how their performance rated against the market.

Perfect. And just a quick follow-up. You outlined a few trends in Lat Am and indicated you still expect some continued weakness. But can you offer a little more color on what you're seeing here and whether or not you believe you've reached an inflection point in terms of the magnitude of operating losses? Thank you.

I think that last year, we earned positive profit in each one of the quarters last year. For the year, we think that this year is going to be the exact opposite. But I do think when you look at the investments we're making, we think we're doing the right long-term -- and we think that the markets are troughing.

I think that when you look at specifically at Mexico and Brazil, we're closer to the end. What we said last year, we felt that Brazil would not -- you wouldn't see an improvement during 2016, maybe mid 2017. I don't think we've seen much difference there with political and so forth.

In Mexico, we think that Mexico is doing better. We think that's doing fine. But Argentina, Chile, Ecuador, we're still having some headwinds there, and so we do believe that for the year, we're going to lose money in Latin America.

As we've spoken in the past, we feel this is an opportunity for us. We see rather than just waiting for the market to correct -- and we do think that the market will improve -- that there are some steps we can be taking. And we're taking those steps, and ensuring we've got the right products, the right channels, and the right people in those markets, and we're making very good progress in the improvements down there. So as the market does improve, we expect to outperform the market.

That's great detail. Thank you very much.

Thank you, Chris.

Ghansham Panjabi, Robert W. Baird.

Hi, guys. Good morning. First off, on the 5.2% same store sales increase that you reported during the quarter, did that come in basically where you thought it would heading into the quarter? And in terms of outlook, do you sense any change in industry fundamentals either in residential or commercial construction or in any particular region within the US? Thanks.

This is Sean Hennessy, and the 5.2% is fairly close to where we were. We had said that in the first quarter that was tremendously strong. We were almost double digits in the comp stores. So we did feel that it was going to be lower than that first quarter, but the 5.2% isn't that materially different than what we had in the guidance.

And regarding the market, Ghansham, I'd say, I spent a great deal of my time with our customers and with our people in this segment, and there is a strong sense of bullishness in this area. There is continued growth in the residential repaint area. This is yet another quarter for us with double-digit gains in residential repaints. Our commercial customers are really speaking, a very solid book that currently exists, as well as the number of bids in the pipeline. So on the architectural side we're really excited about this market.

Okay. Just my second question, in terms of -- maybe you could share the outlook for raw material cost, including titanium dioxide, and inflation more broadly, including labor inflation for the back half of 2016 heading into 2017. I'm asking because industry has not seen a paint price increase since 2013. It seems like the case is increasing for one in 2017. Would you agree with that?

Yes, Ghansham. This is Bob. On the raw material outlook, we still see low mid-single-digit deflation for the full-year 2016. Although you asked specifically about TiO2, the majors in TiO2 we think are probably gaining some traction on the second-quarter price increase that they announced that is off the December 2015 lows.

The implementation at this point, as near as we can tell from an industry standpoint, is probably in the mid-single-digit cents per pound, so not a significant increase in percentage terms. As expected, they've been out with a third quarter announcement. We think that it's likely they may get some traction, but how much they get really depends on customer size, on location geographically.

So we're likely to see some year-over-year inflation on TiO2. As far as the rest of the basket, feedstocks for the latex and acrylic monomer market have been very stable. Chemical-grade propylene has been steady at around $0.31 a pound, so we don't necessarily see inflation in that side of the basket.

And on the labor side, we're putting our game plans together for 2017. We've done a lot of work on 2017, but we don't see -- when their guidance, we still see productivity gains, especially in the Stores Group. So when you look at that labor expense, and we're evaluating 2017 as we go.

And as always before we go -- before we announce to the market what we're going to do with pricing, we would talk to our customers first. So those plans are being developed right now, and if we do go, after we've talked to the customers, we'll be pretty transparent and let you know.

Perfect. Thanks so much.

Thanks, Ghansham.

Jeff Zekauskas, JPMorgan.

Hi, good morning. When you look across the paint industry in the United States and you compare the performance of company-owned stores, whether it's yours or those of other companies, to the amount of paint that is going through the big-box retailers or through channels that are non-company-owned stores, do you see differences in volume growth, or are they comparable?

When you look at the results, I think it's showing up, Jeff, that the painting contractor is the faster growing, that the painting contractor is growing faster than DIY. That's our perception, and I think the facts bear that out.

And in the -- is there a different conduct of the big-box retailers toward inventories? That is, are they taking steps to meaningfully push down their inventories either temporarily or permanently?

I think that our customers have always done a very good job in managing their working capital, and we're constantly working with them. We want to have the right inventory on the shelf, Jeff, and there are times when that means that there is a little lighter in some areas and a little more in others.

And so I'd say it's just an ongoing discussion that we have with our customers. We want to help drive their key metrics, [MOA] or any others that they have. And so as they are reviewing what it is that is working for them, we want to be a part of that.

Okay, great. Thank you so much.

Thanks, Jeff.

Duffy Fischer, Barclays.

Good morning, fellows. Question just on the raw materials again. For Global Finishes, you called out that raw materials was down and a benefit, for Lat Am it was up and a headwind. What is the dichotomy going on there?

I think that Latin America, 100% of raw materials are based on US dollar and are fully affected by the currency changes. In the Global Finishes, we do have a portion of that business that's in the United States, and it doesn't have that same effect, and I think that's really the dramatic difference there.

Okay, great. And then the $0.16 you called out on the acquisition cost, what was that pretax, and where did that roll through the P&L?

Sure. 100% of it went through the admin section. It was $25.2 million pretax, which we wrote down the $15.4 million after tax, which gave $0.16. $4.5 million approximately went through SG&A. The other $21 million went through the interest expense. And again that was 100% in the administrative segment.

Okay, great. Thanks a lot, fellows.

Thanks, Duffy.

Arun Viswanathan, RBC Capital Markets.

Morning, thanks. Just a question on the Paint Stores. I think you do both protective and marine in there. So is it a fair assumption that your architectural sales were above that 5.2%? And maybe you can just gauge what kind of range your protective and marine was tracking in the quarter.

Your first part of the question and your implication is exactly right. Architectural was the fastest growing and was there. The protective and marine was dampened. Really don't have a metric that I think we can share with you that we'd be comfortable with.

I would say this, Arun, is that all along, as we have been going through this, just as we just talked about with Latin America, there are a number of segments within the protective and marine opportunities for our [teams]. And so while we've been experiencing some pressure in oil and gas, the teams are pivoting and really focused on other segments that offer opportunities in both sales and margin.

Okay, thanks. And just similarly on those points, though, would you say that both in Latin America and in protective and marine that you're nearing a bottom in those comps? And does your guidance embed an easing in those comps through the year?

I think so, yes. As we move forward, the comps, we're going to lap those comps, and at the same time, some of the good work our teams -- what they're putting in place right now will continue to positively benefit us going forward.

And I think that even though the comps are getting easier, we're basically saying we're in a trough now. I don't think we're ready to say that we're going to see some major growth in either the Latin America or the protective and marine, but I think we're in a trough.

(Inaudible).

Yes.

And then just the last question, you had it put out earlier that your belief is that you can potentially get to 820 million gallons the next peak. Is that still your belief, and when do you think you can get there this cycle?

It is, Arun. And we base that belief on the fact that the installed base of square footage that requires maintenance has grown pretty dramatically since we considered mid-700 million gallons to be normalized. So this peak should be well above the last peak just at normal build rates, and we're not back to normal build rates yet. We consider normal to be closer to 1.4 million, 1.5 million residential starts and a little stronger non-res activity than we're seeing right now.

Once we get build rates back there, and once the maintenance cycles have returned to normalized repaint activity, we think we're going to see normalized volume in the 780 million, 810 million gallons, and it's very likely that this cycle should peak above that 810 million gallons. Whether that takes three years or five years to get back to, time will tell. At the rate of recovery in the residential market right now, I think that it's probably going to take at least three years to get back there.

Okay, thanks.

Thank you.

Scott Mushkin, Wolfe Research.

Thanks for taking my question.

Good morning, Scott.

Good morning. I just wanted to -- a little longer-term oriented question, just trying to understand. Gross margin is obviously up nice in the quarter, and gross margin has been coming up quite a bit. Obviously, raw material cost has something to do that.

But as you guys look at your normalized gross margins, what are your thoughts about that? Can we still see things come up here? And I just wanted to get your thoughts on that.

I think that the way we run the business, we believe that in the long term, we're going to continue to raise the ROS. I think the gross margin, we've had great expansion. That's basically because of three things, really nice gallon growth, especially in the Stores Group, and integration that is complete now from the Comex North America, and raw materials have been a tailwind, but those things have occurred.

I think that in all cases, we're always looking long term. I like your term -- really looking in the long term.

And again this year, we're taking a balanced approach to where we're going. We're investing. There's times when the gross margin will lead our ROS improvements, and there's times that SG&A -- and back to that gallon growth that we've had in the Stores Group, it's because of innovation. I think we continue to do a lot of innovation, and innovation has helped us in all the different segments.

So when you look at where we're going, this year, our midpoint of our range is $12.60. Last year, it was $11.13, a 13% increase. And when you take a look at it, a challenging global environment and no share buybacks. Our original guidance had approximately $0.25 worth of buybacks in there.

So we're generating net operating cash at record levels, and we're continuing to make prudent investments in the business. So you're going to see SG&A probably this year isn't going to be in the improvement in the ROS. It has to be in gross margin.

And we had the tailwind. We clearly said there was going to be a tailwind. We had the innovation, and we had Store Group [going away]. But we're pretty confident that those investments will earn solid returns in the future, and that's how we do this balanced approach for the long term that you asked.

That's perfect. Appreciate all the color. And just maybe switching gears just a little bit to capacity levels that you guys are seeing right now. Where are they, and what will they look like if you successfully close the Valspar acquisition?

We always have said that we were 88% to 92% is the sweet spot for us, and 2008 and 2009 when the market did go down 25%, 30% in that one year, we managed it. We did not take all the capacity out to get down to that level, and that's where -- the earlier question about the 820, we were shooting for that 750, 770, so that capacity, we live with the capacity in the low 70%. We're now much closer to the 88% to 92%, and that's why our margins are doing very well.

Since then, that North America acquisition of Comex, I think those gallons going into our footprint. But we've hung onto a couple of the assets they have, and when we look at the Valspar, we think that they have some great assets to give us for capacity. We think that gives us another leg in the stool that -- to give us the ability to have that capacity utilization go down in the short term, but then gives us the ability to grow without great deal of CapEx.

All right, awesome. Thanks, guys. Appreciate it.

Thanks, Scott.

Vincent Andrews, Morgan Stanley.

Thank you very much. Just to dig in a little bit more on Consumer Group, you mentioned a couple of programs you were running at retail that didn't get the traction that you were looking for a new, and then you obviously had some increased spending against that. So what is, just broadly or specifically, what's the course correction that you're looking to do? And is it something you can do this year, or is it something that we have to wait until next paint season to see the results of?

I think what's important here is that there is some investment here, and we see it as a clear opportunity. We do go into this with our eyes wide open. We know that there are investments made that may not come back in the first quarter that we make those investments, maybe not the second.

But if you look at our market share in this segment, there's terrific opportunities. We believe a disciplined approach and aggressive approach here can help us to grow our market share and manage our margins for our shareholders. So we're moving in this direction with a very disciplined look. We're making the investments, and we think there are opportunities out there for us to grow.

And just as a (multiple speakers) -- go ahead, sorry, Bob.

And as far as the timing, as you mentioned, we're patient. But we don't see it snapping back in the next quarter or so.

Okay. And just as a follow-up, you mentioned that Consumer Group should improve sequentially through the balance of the year, but should we be modeling 3.2 still flat to down, or how should we be thinking about that on the top line?

On the top line, as you settle sequentially, we'll improve. I think that ?- but with some of the situations we just talked about, we think it's going to be flat to up slightly.

Okay. Thanks very much.

Thanks, Vincent.

Don Carson, Susquehanna Financial.

Yes, thank you. Question first just on your overall impression of the architectural market. Last year was obviously -- I know you don't like to talk about weather, but it was weather depressed, and growth was 2% to 3%. Are you seeing the snapback you expected this year, or has that been moderated again by weather? Bob, what's your outlook for the overall US architectural market growth this year?

Yes, Don. For starters, we don't think there was much weather effect in the numbers this year. We think that build rates are holding up very well, but they're not on fire. Residential construction is up about 10% year over year in square footage terms.

In the commercial market, starts are down, but completions are up pretty significantly year over year, so we're seeing solid demand growth in the new construction market. In the repaint market, while the pro residential repaint business has been really solid, what's hard to determine at this stage because we just don't have the data is how the DIY channel held up in the second quarter.

So I hesitate to say that there's just not enough data to call market growth in the second quarter yet, but I think that's the truth. The contractor market seems to have grown nicely, but it's hard to tell on the other piece.

Okay. And John, a question. Maybe you can update us on Valspar's synergy outlook. To the extent you've been able to talk to your counterparts over there and have meetings about combining the two companies, what's your updated outlook for percentage potential or your updated confidence level in the original target you set out?

I don't think we're going to move the original target, but I think that as time goes on, we continue to feel very confident that we're going to hit those numbers.

Okay, thank you.

Thanks, Don.

Mike Harrison, Seaport Global Securities.

Hi, good morning.

Hi, Mike.

Was wondering if you could give a little more detail on the solid margin performance you had in the Global Finishes Group? I know you mentioned the price and mix was improving. What exactly was driving that, and how sustainable could a number like 13% margin be as we get into the second half in that segment?

I think that when we take a look at that group, the improvement stems from really four focus: driving that product technology I mentioned earlier into the market, improving SG&A, capturing pricing in the ?- where it offset currency, and then capturing reductions in the raw materials as they occur in the United States. These combination of four things I don't think are going to change.

You'll see -- for the longest time, we used to talk about 12%, and I think that this gives us great confidence that we can say 13%, and with the market share gains, I think we can actually beat that number. So I think the game plan has worked very, very well.

Great. And then a question on Latin America. It sounded like you mentioned that you expect to be below breakeven for the rest of the year, but just wondering as we get into the heavier paint season there in Q4, is there a chance that we get north of breakeven? And also wondering if there were some unusual costs in Q2 that help explain a pretty significant sequential weakening in terms of the earnings in Latin America? Thank you.

The answer to the last question is no. There really was no one-time thing that I would point out. I just think it was the operation as it is. I think we come closer to breakeven, and maybe there's a chance that if we have a little stronger sales, the fourth quarter definitely is the closest to the breakeven for the remainder of the year, but right now I would not come out here and say we're definitely going to make money in the fourth quarter.

Thank you very much.

Thanks, Mike.

Greg Melich, Evercore ISI.

Thanks. I have two questions. One was a little accounting and charge clarification, and then the second on business. Sean, the income tax benefit, could you explain what that actually is, and is it just simply as straight as $0.09, $8 million is coming into taxes?

Yes, and what that is is when we've expensed -- when starting the new rules many, many years ago expensing stock option, RSO grants, and so forth, you charge the P&L for the Black-Scholes amount. So whatever the Black-Scholes value was on the day of issuance, basically, you straight-lined it if it was a three-year or a five-year option vesting period.

Then what would occur is if the stock, the differential between -- when the day of vesting, a differential between the Black-Scholes value and the actual value was actually a -- that difference used to go to retained earnings. We always took it on our tax return, and that was one of the differentials between book and cash taxes.

So this change -- this accounting change for us has nothing to do with and won't change our cash performance. But instead of having that differential for us, as you said, in the second quarter, $8 million go to retained earnings, it now goes directly through the P&L.

So that's why it was $0.09 in the second quarter. Year to date, it was $0.28. And the reason why it was $0.19 in the first quarter is because of the -- in first quarter is when the vesting occurred of our long-term RSOs so that many people are on that, so that's why it hit in the first quarter. Second quarter was really driven by stock options that were exercised.

So that's what it is. It does have a cash differential. That's why we pointed it out. We adopted it this quarter so we could do the accounting this way. I think as time goes on, I think January, everyone has to go on it, so I think, well, we took the opportunity to do it now just to get this noise out of our P&L next year.

And so we should see something else in the next two quarters?

Yes.

More like the second quarter, not the first (multiple speakers)?

Right. And just so you know, when we tried to say we guesstimated that that number will be $0.45 for the year. So when we were talking about when we show that schedule in the back, that's where that $0.45 comes from. So 2017 -- we're saying 2017 and the next two quarters, so 8.5 a quarter, something in that range.

Thank you. That's a great catch up. So then back to the more fun stuff, Sean. I guess what will be helpful is understanding the -- through the quarter, I think there were a couple questions, to tease it out. If I remember last year, we had a wet June, and that may have had some impact. Would you say that the business was quite steady in Paint Stores Group through the quarter, or was there strengthening or weakening, or how would you put that together?

I would say is pretty steady if you compare apples to apples, Greg. The performance inside stores tilting in the right direction but consistent throughout the quarter.

Okay, got it. And I think in the prepared comments, you mentioned that in Consumer, what was weaker than expected was other retail programs. I think -- I hope I wrote that down right.

Explain to us what that is. Is that other architectural paint programs? Is it some of the spray paints or sealants? Or give us a little more color that would be helpful.

There's a few things we're working on, Greg, and quite frankly, we prefer that our customers start talking about that when the timing is right. We're leaning forward in that area. As I mentioned, and it is important in a very disciplined fashion, we didn't feel as though the return would come back in the first quarter.

Sales wise, we have high expectations for our sales, and we're going to continue to push to grow our sales. We have a high regard for our team there, and they're pursuing some opportunities with customers in a number of different channels and a number of different segments and spaces. It's not one but a number of areas that we are investing in and believe that we can grow.

But it specifically wasn't the HGTV, that cycling the sell in last year that was on plan?

That's correct.

Thanks, good luck.

Thanks, Greg.

Nils Wallin, CLSA.

Good morning, and thanks for taking my question. First is on non-res starts, as Bob, I think you said completions have been good this year, so that's obviously helping your business. But starts themselves have been down meaningfully in the first part of this year. Does that mean there is going to be a fairly significant headwind next year, and what might you do to get ahead of that?

Yes, Nils, on average, as we typically point out, the time between starts and completion runs about 20 to 22 months in the nonresidential space, which means that next year, we're primarily going to be completing 2015 starts. 2015 was a pretty strong year. Not as strong as 2014.

2014 was the strongest year since the recession. 2015 was the second strongest. And today, so far, year to date, we're running down about 9% in square footage of starts. So we will see the nonresidential market trend downward in terms of completions over the next couple years.

As a reminder, the non-res market, you're talking about a third of the new construction pieces of market, which new construction totals less than 20%. So it will be a headwind in out years, just not a real significant one.

Got it. And then at your recent Investor Day, you guys highlighted quite a bit of the innovation, particularly Paint Shield. Wondering how that's tracking. And obviously, tying into the non-res starts, there has been quite a bit of strength in healthcare, so wondering if you've been able to get in on the ground so to speak?

I'd say with a new technology like this, as expected in this area, that there will be a little bit of a ramp up. We're working with a number of different decision makers and influencers in this area. Trend wise, it's going in the right direction, and we're going to continue to focus on it. But the comparisons as we go forward here, we expect to continue to improve.

Understood. I'll pass it on.

Thanks, Nils.

Ivan Marcuse, KeyBanc Capital Markets.

Great. Thanks for taking my questions. First one, can you give me the gross profit changes on the Paint Stores consumer in Global and Latin America [given the chance]?

Sure. Paint Stores Group was an increase of $116 million. Consumer was flat. Global Finishes was up $2.5 million, and Latin America was down $13 million.

Great. And in terms of the Paint Stores, the contribution margin has been pretty large, and I know that's partly due to the volume leverage and outflow of raw materials. As raw materials level out, do you look for that contribution margin to go back to the traditional 25%, 30% type of flow-through to the bottom line as you go into the back half?

I think the 60%, 70% flow throughs are nice, but you're right, it's not just the raw materials. We're fully integrated now with that Comex, and those things have really helped us over the last two, three years. Yes, we see us [having advantage]. We still have great flow through, but probably, you're going to see it closer to the -- maybe a little higher than what we've done in the past, but yes, it will.

And then the last question. In terms of the acquisition-related costs, how much of them -- what are the big buckets these costs are going into, and how much of them are cash? And are they big enough where you're getting ahead of what costs -- what costs may be when the deal finally closes in the first quarter?

Sure. In the first quarter, the acquisition cost -- I'm going to just speak to [PB] to you. I won't talk about -- unless you want me. But if you take a look at the big buckets, they were our advisor fees there. And then another big piece of that niche, that's the cash out in the third quarter because of the timing and so forth.

But that plus the bridge and term loan fees, we're amortizing those bridge and term loan fees today. That's cash. Then we have some legal fees that are cash. But the big hit will be Valspar's advisor and legal fees which will occur at the close.

So when we look at that $0.72 that we show in the fourth quarter to finalize the 132, a majority of that is going to be a cash hit. That's why a lot of times we look at the cash needed to close this $11.3 billion, we look at it closer to $11.5 billion because we have these $200 million worth of pretax closing costs in total, the majority of which will be paid back at that time.

Great, thanks for taking my questions.

Thank you, Ivan.

Chuck Cerankosky, Northcoast Research.

Good morning, everyone. Most of my stuff has been covered already, but I want to go back to the Consumer segment. And in just focusing on the segment rather than the customer, John and Sean and Bob, how would the sales change year over year have looked if you could take out the load-in sales of a year ago?

It would be up slightly.

So 2%, 3%? Is that a good way to put slightly?

Yes.

All right, thank you.

Thanks, Chuck.

Scott Rednor, Zelman and Associates.

Hi, good morning. Question for Sean. When you're referring to SG&A being elevated for the balance of the year, the 70 basis points of deleverage that we saw in 2Q, is that the run rate we should consider for the back half of the year?

I think you're not going to be far off. It's not going to be exactly that, but that's probably not a bad number.

And then when we think about the 70 basis points in 2Q, is that all Consumer, or are there investments elsewhere that cause deleverage?

I think the majority of which was in Consumer, but LACG. We're still investing in Stores. I think the Stores investments have not changed. We think this is a continued driver. So the SG&A increase as a percent of sales was not in Stores, but we still are investing in Stores as heavy as we ever have been.

Right so just a [tail-end] question. Maybe the Consumer, given that you had a heavy investment last year and then you have heavy investment this year that might be related to other programs. Do you think this is needed to sustain that flat to low single-digit growth you guys have guided to longer term? Or should we expect the growth rates to be better than that once you get a return on these investments?

We're going to be trying to drive that higher, Scott. The investments that we are making here we believe can help us.

Fair enough. Thank you.

Thanks, Scott.

Rosemarie Morbelli, Gabelli and Company.

And good morning, everyone. I guess it is still morning. I was just wondering if on the Global Finish Group, you could talk a little bit about the areas where you are seeing some improvement outside of oil and gas, which markets and which industries are actually growing?

Inside our Protective and Marine we're focused on a number of them. Rosemarie, I'd prefer not to highlight those for obvious reasons. But our teams are really pivoting into some areas where we've had some presence in the past, but we feel as though we could be more meaningful in the marketplace, and so we're investing in sales rep time and specification effort as well as some product development to help us.

So as we're pursuing these segments, sometimes adversity brings out the best. We're finding that we have technologies that will help customers in adjacent segments. We have people that are knowledgeable and that we can pursue better. So we're after them. I'd rather not highlight them right now, but rest assured that we're out there pursuing them.

So when we look at the industrial world or the industrial market, what you are saying, if I am -- just making sure I understand, is that you don't want to talk about those particular areas which are actually doing better than what we read in the paper, for example?

That's correct. And some of the areas that we just have a lower share in that are very profitable segments that we can increase our share in.

Okay. And for Sean, if I look at that impact on the interest expense from the acquisition expenses, so I am actually calculating that your regular interest expense is $20.2 million, more or less. Is at the right number to look at for the balance of the year until you are actually borrowing full [boat] for the Valspar acquisition?

Yes, it is. We did borrow last year in July, and so we've now fully anniversaried those bonds that we issued. So we're 100% fixed right now, which is that we're not in any variable interest. That's a very good rate. That $20 million is a very good number.

Okay. And then lastly, if I may, and you may not want to respond to it, but anything new on the regulatory front regarding the Valspar acquisition?

Well, I wouldn't say that there's anything new. We disclosed that we see the second request, and we're working with the FTC to provide all the information that they need to complete their review. So we're trying to be as responsive as we can to provide them with the information that they are asking for.

And with that in mind, you still expect to close at the end of the first quarter?

We still are anticipating closing in the first quarter, yes.

Okay, thank you.

Thanks, Rosemarie.

Thank you.

John Roberts, UBS.

Thanks, guys. Housing may not be at peak again yet, but Cleveland certainly seems to be on a higher end now.

On a roll.

I think [in the last poll], we're in the Indians in the World Series. (Laughter)

There's a lot of questions on the call here about the sustainability of the paint demand at these levels. On your pro customers, do you have insights into their backlogs? When you talk about them being bullish, do you think their backlogs or business are higher, or just because there's been such a strong first half, they've probably run off a fair amount of backlog that it would be hard for them to maintain the same level?

Actually, John, the discussions I've had with many customers around the country would say that they've got a good book of business that they're dealing with right now. They've got a good book of business that they have in the pipeline, either secured or believe that they're going to secure, but what gives us, perhaps, most excitement is the pipeline of bids that they're looking at down the road. They also feel -- that's what I mentioned earlier, that they are bullish about those as well.

All right. Are they buying spray equipment and ladders that would be supportive if they have a lot of confidence in their outlook?

They are, yes. I'll say that our -- we have strong equipment sales as we pointed out in the first portion of our discussion.

Okay, great. Thank you.

Thanks.

Bob Koort, Goldman Sachs.

Hello, everyone. This is Chris Evans on for Bob. Just in your 2016 guidance, I was hoping you could give me a little more directionality or specificity on your same store sales number that you're implying?

I think that we've never broken out segments inside our guidance, but I think what we freely have said for probably 14 quarters in a row, when you look at that guidance number, the Stores Group again will lead our sales in the third and fourth quarter and for the full-year. So I think that the first half of the year is probably a pretty good indication of where you'd see, when you break out your sales in the model, that Stores is going to be number one, and those counts are going to be strong.

Thanks, Sean. And another year, you're expecting 90 to 110 net new stores. You've put out some pretty good targets out there on 6,000. Can you talk about what gives you guys the confidence to say that you're not hitting or you won't hit a saturation point or some diminishing returns with that level of continued growth?

I'd say we've spent a lot of time on this metric. We've been watching to see how the new stores today are creating cash, and the metric versus the metrics we've done over the years. We compare it to the market. We compare it to how that market is in relative size of store per household. And the metrics have all been going in the right direction, which would tell you if you're incremental stores continue to perform like that and the markets are performing, that you're probably not at saturation point.

Because we often cite that we're blessed with a number of very good competitors, and there's plenty of opportunity out there for us to continue to grow. New stores is one channel for that.

Great. And then just one more really quick one. With share repurchase guidelines, decent amount of dilution in the quarter. Just wondering, is that a reasonable run rate to expect as we go through the year, or is that unique of this quarter?

I think it's pretty reasonable. When we look at what we think our share count would be in the fourth quarter, because of that dilution, it's slightly higher than in the second quarter. But I think your point is well taken.

Again, approximately $0.25 of our original guidance we came out in January with had share repurchase. So when you look at the share count, if you go out to the fourth quarter and have a slightly higher number than the second quarter, I think you're in good shape.

Thank you.

Thank you, Chris.

Eric Bosshard, Cleveland Research Company.

John, I wanted to circle back. You had talked about steady sales month to month in the quarter, and hearing pretty good things from the customers, the painters from the channel in terms of what's going. Curious how when you look at the comp of 9 in the first quarter and 5 in the second quarter and with the guidance it implies, the 2Q comp is the right number through the rest of the year, something in that neighborhood. What's the difference between 1Q and 2Q?

The size of the number, obviously. When you look at the first quarter, just the raw number versus the second has an impact on it, Eric. And what I was speaking to us far as the comparisons month to month, we didn't see any significant highs and lows within the quarter, that they were pretty consistent in our year-over-year comparisons.

Okay, and I understand the scale, the magnitude of the quarters can make -- can hide the impact or overstate a little bit the impact of growth, but were there pieces of the business that just grew faster in 1Q than they grew in 2Q?

Not that I can think of. Again, not to be too repetitive here, but we had a terrific quarter. And then in residential repaint, double-digit gains. As we talked about in the first portion of our comments about the whole residential, new residential, DIY, all performing well. I don't know that there was any significant swings from the first quarter to second quarter.

Okay I'll circle back to get into more detail then. Thank you.

Thanks.

David Wang, MorningStar.

Hi. Thank you for taking my question. I just had two. First is I need a little more understanding on the margins. Overall incremental margins around 36%, with Paint Stores performing particularly well.

Are we close to the sweet spot in your capacity utilization? And if so, is there much operating leverage remaining as we ramp up to what your estimate for mid-cycle paint volumes would be, or is this going to be more of a headwind going forward where we wouldn't see as much incremental margin for new paint volumes?

I think that we're getting closer to the sweet spot. I think that there is still some room when it comes to looking at that incremental margin. I think when we were in the low 70%s, we had a great deal of room, and so you saw a greater impact.

But I do think the incremental margins will still be strong. They'll be higher than ROS today. And I think that's key for us.

We are always trying to make sure that our incremental margin, our incremental flowthrough, as we call it, is greater than our current ROS. I still see that happening. I just don't see it happening at the 60%, 70% incremental margin.

We've got a terrific Operating Team that's constantly working to improve and unlock capacity in our facilities, and so that process continues, and got a wonderful team there that is working diligently to do that on a regular basis.

So apparently we're not at the 80%, 90% or so utilization?

That's true.

Great. And then a second question on normalized paint volumes. I think your new forecast for 780 million to 110 (sic - 810) million gallons is a bit higher than your prior forecast I think what we discussed a few years ago, normalized volume is around 760 million. That's probably closer to what we are at today.

And looks like a large portion of the difference between the previous expectation and your new one is higher mid-cycle levels for res repaint and DIY. Have you guys discussed having a larger base of homes that would need repainting, but to the extent that the mid-cycle new res forecast has hasn't changed much, is it that we just expect that the cycle to have a much bigger rally in the near term before normalizing the mid cycle? Or what is driving the main difference?

David, the question you're asking is why is what we consider normalized growing. I think you answered the question. It's growing because the base is growing. And if you look at the overall US architectural paint market, more than 80% of average annual volume goes toward repaint. It's applied to structures that already exist.

If you look at that 740 million to 760 million normalized range, that dates all the way back to the late 1990s, and we've had three building cycles since the late 1990s that have put a lot more square footage in place. Our population has grown significantly since then. So we think it's reasonable to adjust the normalized expectation up based on primarily repaint up volume.

The other thing you see is as the housing market continues to improve and get healthier, and that health is oftentimes reflected in home values, you'll see the frequency of repaint activity increase. So at the peak of the cycle, people are painting more, just like they're remodeling more.

So will there be no change to your estimates for, say, housing starts for the peak or normalized?

Well, no. For normalized you have -- normalized [bands] would assume housing starts in the range of 1.4 million to 1.5 million. We think that's sustainable given our current rate of household formation.

Great, thank you.

Thank you.

Brian Lalli, Barclays.

Thanks for the time here late in the call. I do appreciate it. Just a quick question from the debt size, and I apologize if I missed any prepared remarks on this, but could we get an update on the plans for the longer-term debt financing around the Valspar acquisition?

And then secondly, as a follow-up to that, Moody's specifically had comments on the ratings front being at risk for a downgrade potentially, even out of investment grade depending on the structure. So if you could maybe just comment on your commitment to IG ratings and just how that might guide your financing decisions as we get closer to closing, that would be helpful. Thanks a lot.

First of all, what we've said -- and I'm going to give you -- I don't have this in front of me, but I think I'm going to be very close. Bob can tell us on the financial community presentation, that's out in the Sherwin.com under IR. So we have a schedule, and I actually show you what we think our debt to EBITDA will be all the way out to I believe 2020. So I'd ask you to that.

But I think what we try to show there is at the day of close, our leverage is going to go over 6%. If we close -- and based on closing in the first quarter of 2017, our debt to EBITDA would be over 4%, approximately 4.25%, and so by 2019, we'll be at 3%, and by 2020 at 1.9%, which is under 2%, and I think that's a big goal by 2020 to be under 1.9%.

What we've said is -- and I will answer it this way because immediately after that financial agreement presentation, we were asked, does this mean you're not going to buy any stock through 2020. And I said no, we are going to buy stock when we our debt to EBITDA starts approach 2.5% to 1%. So that will give you a little picture what we're thinking.

And then on the Moody's front, I think we read the same thing from Moody's. Every summer after the second quarter, we've always had an individual meeting with Moody's and Fitch and S&P. We did have a meeting prior to the announcement of the Valspar acquisition, which is some of the -- and I think we are going to go see all three of the rating agencies during this quarter, and we're optimistic that we'd keep the investment-grade.

Investment-grade is very important to us because in the first quarter of every year, our cash flow is negative because we're building inventory for the season. So we're into commercial paper. We want to be in the A1P1. We don't want to have one of them not be an investment grade.

We take a look at the metrics, and we feel pretty good about the metrics long term. And so investment grade is pretty important to us.

Okay. Thanks for the response. Appreciate it.

Thanks.

Rich O'Reilly, Revere Associates.

Thank you. Good afternoon now, gentlemen. On the protective and marine business, I thought in your opening comments you talked about that under the Paint Stores Group. Was I correct?

Yes.

Okay. Is there also protective and marine in the Global Finishes segment?

Yes, that is correct, Rich. In fact, protective and marine cuts across three segments. There's also some protected and marine business in Latin America.

Oh, okay, fine. So is your comment that you made for under the Paint Stores Group preferable to all three other segments, to the other segments, about protective and marine being down?

Yes. In terms of the impact of current oil and gas pricing and the depression in mining activity, yes.

Okay, fine, thanks. In the Paint Store Groups for protective and marine, it's being sold by the local stores versus one of your major distributor centers? Is that the difference there?

That's correct. We use the 4,000-plus stores as a point of distribution.

Okay, great. Second question is, I don't want to sound stupid about this, but in the Consumer Group, when you talk about making investments, I'm not sure exactly what that means, if it means your people in the stores training the store's people, shelf space? Can you elaborate a little bit on that?

I think, number one, that's a partial list, but all three of -- all the things you just mentioned, plus different point-of-purchase materials, displays, maybe even tinting equipment, color matching equipment, all of that will go into that.

Okay, so that's what you mean by making the investments. Okay. Thank you, gentlemen.

Thanks, Rich.

Matthew Skowronksi, Longbow Research.

Good morning, guys. I'm Matt Skowronski on for Dmitry. Looking at Brazil and Latin America, Brazilians, you're flat year over year. Do you guys expect positive FX comps in the second half, or are other currencies going to weigh you down with the peso, the Argentinian peso?

Don't worry about the Argentinian peso. The four currencies that drive us, and I'm talking specifically Sherwin, the Brazilian Real, which is better than it was in the first quarter but was still a headwind in the second quarter. We were still in the $3.11. We expect that possibly by the fourth quarter, that's not going to be a headwind; that's going to be a tailwind.

The second is Canadian dollar. The Canadian dollar has continued to be weak, so we expect that's going to be a headwind for the remainder of the year. The euro, which is relatively flat, and so we think that's -- but we have a big presence in the UK, and with the RONSEAL brand, the [Leaf] Paint brand, the Geocel, and the Great Britain pound is now a headwind, and a significant headwind.

Perfect. That's all the questions we have. Thank you so much.

Thanks, Matt.

Thank you. It appears we have no additional questions at this time, so I would like to turn the floor back over to Mr. Wells for any additional or concluding condiments.

Thanks again, Jesse. As always, I will be available over the next few days to handle any additional questions that arise out of this morning's call.

If you'd like to be placed in the queue for a follow-up call, please call Christy Johnson at 216-566-3001, and she will add you to the callback schedule. That number again, 216-566-3001. I would like to thank you again for joining us it again today, and thank you for your continued interest in Sherwin-Williams.

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