宣偉 (SHW) 2017 Q3 法說會逐字稿

Good morning. Thank you for joining the Sherwin-Williams Company's Review of Third Quarter Results for 2017.

With us on today's call are John Morikis, Chairman and CEO; Al Mistysyn, CFO; Jane Cronin, 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 2 hours after this conference call concludes and will be available until Monday, November 13, at 5:00 p.m., Eastern time.

This conference call will include certain forward-looking statements, as defined under U.S. federal securities laws, with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date on which such statement is made, and the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. A full declaration regarding forward-looking statements is provided in the company's earnings release transmitted earlier this morning. (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 have provided some balance sheet items and other selected financial information, including a slide deck with a breakdown of results by our new reportable segment on our website, sherwin.com, under Investor Relations October 24 press release.

I'll begin by highlighting overall company performance for the third quarter 2017 compared to third quarter 2016 then comment on each reportable segment.

Consolidated net sales increased 37.4% or $1.23 billion to $4.51 billion due primarily to Valspar sales and higher paint sales volume in The Americas Group and Performance Coatings Group, partially offset by the impact of the hurricanes in Texas, Florida and the Caribbean. Excluding Valspar results, core consolidated sales increased 4.6% over the third quarter last year, with a significant portion of the increase coming from sales through our North American paint stores.

Consolidated gross profit dollars increased $265.7 million or 16.2% to $1.9 billion in the quarter. Our consolidated gross margin decreased 770 basis points in the quarter to 42.2% of sales from 49.9% in the third quarter last year. Excluding the impact from Valspar, core gross margins declined 140 basis points in the quarter to 48.5% of sales.

Selling, general and administrative expenses increased 24.4% or $256 million over the third quarter last year to $1.31 billion. As a percent of sales, SG&A decreased 300 basis points to 29.0% in the third quarter this year from 32.0

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$47.5 million compared to the third quarter last year to $91.6 million. This increase was entirely due to acquisition-related interest expense.

Amortization increased to $83.7 million from $8.2 million last year due to the increase in intangible assets related to the Valspar acquisition. Consolidated profit before taxes in the quarter decreased $107.9 million or 20.1% to $427.7 million. Excluding the impact from Valspar, PBT declined in $19 million or 3.3% to $553.4 million, which includes a $42 million negative impact from the natural disasters in the quarter.

Our effective tax rate in the third quarter was 26.0%. For the full year 2017, we expect our effective tax rate will remain in the mid to high 20% range.

Consolidated net income decreased $70.1 million or 18.1% to $316.6 million. Net income as a percent of sales was 7.0% compared to 11.8% in the third quarter last year.

Diluted net income per common share for the quarter decreased 18.4% to $3.33 per share from $4.08 per share in 2016. The $3.33 per share includes $1.42 per share in acquisition-related expenses, including inventory step-up and purchase accounting amortization and income of $0.49 per share from Valspar operations. We have summarized the year-over-year earnings per share comparison in a Regulation G reconciliation table at the end of our third quarter 2017 press release.

Looking at our results by operating segment. Sales for The Americas Group in third quarter 2017 increased $154.7 million or 6.5% to $2,540,000,000 from $2.38 billion last year. This increase was primarily due to higher architectural paint sales volumes across most end markets and selling price increases, partially offset by the impact of the hurricanes, primarily in our Southeastern and Southwestern divisions.

Sales in the Latin America region, stated in U.S. dollars, increased 4.9% in the quarter. Comparable store sales in the U.S., Canada and the Caribbean, that is sales by stores open more than 12 calendar months, increased 5.2%. Regionally, in the third quarter, our Canada division led all divisions, followed by Midwestern division, Southwestern division, Eastern and Southeastern division. Sales and volumes were positive in every division.

Segment profit for the group increased $6.3 million or 1.2% to $525.6 million in the quarter, as higher architectural paint sales volumes and selling price increases were partially offset by higher raw material costs and the negative impact of the storms in the quarter. Segment operating margin decreased to 20.7% of sales from 21.8% in the third quarter last year.

Turning to the Consumer Brands Group. Third quarter sales increased $325.1 million or 81.6% to $723.3 million due primarily to the inclusion of Valspar sales, partially offset by lower volume sales to most of Consumer Group's retail customers. Excluding sales from Valspar, core sales for the group decreased 2.7% in the quarter.

Segment profit for Consumer Brands decreased $16.8 million or 19.2% to $70.4 million in the quarter due to acquisition-related inventory step-up and increased amortization costs totaling $54.6 million and higher raw material costs that were partially offset by improved operating efficiencies, good expense control and selling price increases. Excluding the Valspar impact, core segment profit was essentially flat year-over-year.

Segment profit as a percent of external sales decreased to 9.7% from 21.9% in the same period last year. Most of the impact in segment profit margin was from acquisition-related expenses, negative margin mix from the addition of Valspar businesses and higher raw material costs. Excluding Valspar, core operating margin for the group increased 50 basis points to 22.4%.

For our Performance Coatings Group, sales in U.S. dollars increased $746.9 million or 150.8% to $1.24 billion in the quarter due to the addition of Valspar sales, higher core paint sales volume and selling price increases. Excluding Valspar, core sales for the group increased 2.1% in the quarter.

Stated in U.S. dollars, third quarter segment profit decreased $8.4 million or 12.4% to $59.6 million due primarily to acquisition-related inventory step-up and increased amortization costs totaling $102 million. Excluding Valspar, core segment profit declined 15.9% in the quarter. As a percent of external sales, segment profit decreased to 4.8% from 13.7% in the same period last year. Excluding Valspar, core operating margin for the group decreased 240 basis points to 11.3% of sales.

That concludes our review of the third quarter results for 2017, so I will turn the call over to John Morikis, who will make some general comments and highlight our expectations for fourth quarter and full year. John?

Thank you, Bob. Good morning, everyone. Thanks for joining us.

Third quarter 2017 was a challenging quarter, particularly for those living in the path of the violent hurricanes and earthquakes we all witnessed. I think it's fitting that I begin my remarks this morning by acknowledging and thanking all the Sherwin-Williams associates in Texas, Florida, Georgia, the Caribbean and Mexico, who served countless hours of volunteer work in the disaster relief and cleanup efforts, went above and beyond the call of duty in helping our customers get back on their feet and got our stores and facilities up and running in record time. These communities are home to Sherwin-Williams, and that point is very evident in the ongoing efforts of our people.

Our results in the third quarter were slightly better than the revised expectations we communicated back on September 27. Although the storms and earthquakes disrupted the operations of as many as 650 paint stores, the impact in terms of lost sales in the quarter was at the low end of our expected range of $50 million to $70 million. This good news, if you can call it that, was offset by moderately higher-than-expected raw material inflation as a result of storm-related supply interruptions, primarily in the Houston petrochemical complex. The combined effect of lost sales, higher raw material rates and LIFO charges taken in the quarter decreased our third quarter consolidated gross margin by about 30 basis points.

The hurricane disruptions also pushed our full year estimate of industry-average raw material cost inflation to the high end of our mid-single-digit range. The spike in some raw materials is likely temporary and should diminish as propylene and ethylene production returns to normal. Others may have a longer-term impact. In neither case, higher year-over-year raw material costs and LIFO will be a stronger headwind to earnings in the fourth quarter than they were in the third quarter. The October 1 price increase in our North American paint stores should help to mitigate the impact of higher raw materials. Similar actions are underway, as needed, in our other lines of business.

Natural disasters of this nature have a disproportionate effect on profitability because lost sales and gross profit cannot be offset in the short term by reduced operating expenses. In total, these events decreased our earnings per share in the quarter about $0.27 compared to the $0.35 impact we anticipated at the end of September.

The sales momentum we saw across most of our North American businesses, prior to the storms, was encouraging. Comparable store sales growth in our North American paint stores is running in the high single digits, and that momentum appears to be resuming as the effects of the storms diminish. Even with the storm impact, sales to residential repaint contractors grew double digits in the third quarter, and DIY sales through our stores grew high single digits. Consumer Brands Group and Performance Coatings Group both showed sequential revenue improvement in the third quarter, and we expect that progress to continue as well.

The natural disasters last quarter did not derail our plans for new store openings. In the first 9 months, The Americas Group opened 50 net new stores and added 104 new sales territories in the U.S., Canada and the Caribbean, bringing our total store count in the region to 4,230 compared to 4,141 a year ago. Our plan for the full year still calls for store openings in the range of 90 net new locations in the U.S., Canada and the Caribbean compared to 94 last year.

In Latin America, we added 11 net new stores and added 44 new dedicated dealer locations in the first 9 months. We currently operate 350 company stores and sell our products through 682 dedicated dealer locations compared to 316 and 619, respectively, a year ago.

Thus far, integration plans and synergy progress continue to track with the expectations we communicated as recently as October 3 at our Financial Community Presentation. We remain focused on strengthening the performance of both our core businesses and our newly acquired businesses. This focus includes implementing appropriate pricing initiatives to offset increasing raw material costs and continuing to focus on volume improvements in all businesses and all regions.

In the first 9 months of 2017, we generated $1.26 billion in net operating cash, an increase of almost $300 million, compared to the first 9 months of 2016 and greater than 11% of net sales. On September 30, the company had $208 million of cash on hand that will be utilized to reduce debt and fund operations. The company made no open-market purchases of common stock in the 9 months ended September 30, 2017.

Year-to-date capital expenditures totaled $143 million, and we anticipate approximately $200 million in capital expenditures for the full year. Depreciation through 9 months was $162 million. And total amortization, including purchasing accounting and inventory step-up, was $233 million.

Incremental depreciation and amortization related to Valspar acquisition purchase accounting has been revised to approximately $300 million on an annual basis. Purchase accounting inventory adjustments of $114 million were amortized over June, July and August 2017.

The Regulation G reconciliation table near the back of this morning's press release includes $1.04 per share of full year transaction and integration costs, which is up from our second quarter guidance of $0.60 for full year. This increase reflects the cost of facility consolidations that had not been announced as of our second quarter release.

The balance sheet reflects preliminary purchase accounting balances and incremental debt of approximately $9.5 billion used to fund the acquisition. Net payments of long-term debt totaling approximately $700 million were made in the 9 months ended September 30, 2017.

Last week, our Board of Directors approved a quarterly dividend of $0.85 per share, up from $0.84 last year.

As I mentioned a moment ago, we are encouraged by the continued momentum in our business. While fourth quarter is a lower demand quarter from a seasonal perspective, we believe a strong fourth quarter can help us make up some of the lost revenue and profit from the third quarter. As such, we are maintaining our outlook for our full year consolidated earnings per share, excluding Valspar-related costs, of $15 per share at the midpoint of the range.

For the fourth quarter, we anticipate our Sherwin-Williams core net sales will increase a mid- to high single-digit percentage compared to last year's fourth quarter. In addition, we expect incremental sales from the Valspar acquisition to be approximately $1 billion. At that anticipated sales level, we estimate diluted net income per common share in the fourth quarter of 2017 to be in the range of $1.97 to $2.27 per share, including a $0.98 per share charge from costs associated with the Valspar acquisition and an EPS contribution of $0.15 to $0.25 per share from Valspar operations.

The increase in Valspar operations includes an acquisition financing expense charge of $0.39 per share in the fourth quarter. Fourth quarter 2016 earnings were $2.15 per share and included a $0.22 per share charge for acquisition-related costs.

For the full year 2017, we expect Sherwin-Williams core net sales to increase by mid-single-digit percentage compared to full year 2016. In addition, we expect incremental sales from the Valspar acquisition to be approximately $2.5 billion in 2017.

With annual sales at that level, we're updating our guidance for full year 2017 diluted net income per common share to be in the range of $11.20 to $11.50 per share compared to the $11.99 per share earned in 2016. Full year 2017 diluted net income per common share guidance includes $3.21 per share charge from costs associated with the acquisition of Valspar and includes an EPS increase of $0.75 to $0.85 per share from Valspar operations. The increase from Valspar operations includes an acquisition financing expense charge of $0.96 per share for the full year. Full year 2016 earnings per share included an $0.86 per share charge related to the Valspar acquisition.

Again, I'd like to thank you for joining us this morning, and now we'll be happy to take your questions.

(Operator Instructions)

Our first question is coming from the line of Jeff Zekauskas with JPMorgan.

It's difficult to look at the Valspar numbers year-over-year because the months of their quarter are different than -- the months of their quarter are different than your months. Did the Valspar numbers -- did the Valspar volumes and price shrink in the quarter? And is that what you expect for the fourth quarter? Can you frame what's happening in the year-over-year operations of Valspar?

Jeff, this is Al Mistysyn. I would say the Valspar performance in the quarter is really right where we expected it to be. We had an EPS guidance of $0.50. We came in about $0.49. So the trend that you saw and the volumes, which were holding up fairly well, specifically on the Performance Coatings side, continued. And the margin pressure that we've been under also continued. So both expected in the quarter and we saw that. In the fourth quarter, certainly, we'll see some pickup in our pricing activities as our price actions roll in. We'll see some of that in our fourth quarter, but we'll see more of that in our first quarter and with sales being a little bit lower in our fourth quarter. That's why you see the impact of EPS in our fourth quarter, which we guided to $0.20 versus the $0.49 we saw in the third quarter.

So is Valspar growing?

They are growing. Volume is growing. And what we should expect to see, and we'll guide this in our 2018 guidance, is what the impact of the pricing will be.

Our next question is coming from the line of Kevin McCarthy with Vertical Research Partners.

A couple of accounting questions, if I may. First, you indicated in your press release that the purchase accounting inventory adjustment was $115 million across June, July and August. Would I be correct in taking 2/3 of that figure, or $76 million to $77 million, for the impact in the third quarter? And if so, how would that be allocated among your segments, please?

So Kevin, yes, that would be correct. You could take 2/3 of that amount for the third quarter. Allocated across the segments would be about $41 million in Performance Coatings in the quarter and about $34 million in Consumer Brands in the quarter.

And then second, I noticed that you're now expecting incremental D&A related to purchase accounting of $300 million. Whereas, I think at your Investor Day, you were closer to $270 million, if my memory is correct. And I was wondering if you could comment on what changed in recent weeks.

So Kevin, really, as we go through the process of the valuation, we're reviewing that, really, month-to-month to finalize what values are on trademarks, customer lists and that. And what you see in that increase is a little bit of a switch from goodwill to more finite life intangibles. And that's why you saw the increase. I don't expect it to change materially going forward. But if it does, we certainly would give you an update.

The next question is coming from the line of Arun Viswanathan with RBC Capital.

Could you guys discuss a little bit more on the volume performance in the quarter and your outlook? I'm just curious. In Paint Stores, you had a pretty decent showing versus the last couple of years on Q3. So do you think that kind of mid-single-digit growth is sustainable?

Yes. We're pretty pleased with the performance of our stores. And if you look at that progress that we've made, we've mentioned this before, our Pro business, we'll grow the Pro business in our stores by $0.5 billion in the year if you back out DIY and Protective & Marine. So we are feeling pretty good about the momentum that we have in our store's organization. And that does -- I'm going to take into account also the storm. So we talked about the momentum that we had going into the storm. We did take a short pause in the period of the storm. And then as we mentioned, we feel as though it's picked right back up where we were running.

And Arun, what I would add to that, in the fourth quarter, we guided sales mid- to high single digits. And as you know, historically, what that tells you is our Paint Stores Group will be in the high end of that range. We'll have some price in there from October and November, but you certainly are seeing volume in that forecast as well.

Okay. And then on Coatings and Performance Coatings, what's kind of your expectation on the cadence of margin recovery there? Do you expect these price increases to gain momentum next year? And ultimately, when do you think you can get that segment back to where it should be?

Yes, I don't think we're going to have to wait till the end of the year, although the largest majority of it will likely come towards the end of the year. We are, as we've talked before, very determined in our efforts here. And we're going to start seeing -- we'll start to see some of that benefit here in the fourth quarter largely after the first quarter. There'll be some due to some agreements that may lag even into the beginning of the second quarter, but for the largest part, we should see the recovery back in the first quarter of next year. But we'll see some here in the fourth quarter.

The next question is coming from the line of Robert Koort with Goldman Sachs.

This is Chris Evans on for Bob. Just wondering if you could tell us how pricing shaped up in the third quarter for Paint Stores Group. And then also, in the third quarter, was pricing positive across much of the Valspar portfolio?

Yes. So in the price increase for stores, our Paint Stores realized about a 2.5% effective price increase in the third quarter this past year from the 3.5 -- 3, I'm sorry, 3% to 5% price increase effective December 1, 2016. And Chris, we exited the quarter at a slightly higher run rate than that. So implementation of our October 1 price increase here that we just announced is in progress. And we expect the timing and effectiveness to be similar to the December increase, roughly about 9 months, with 75% realization. It's fair to say we're obviously experiencing some margin compression across most of our lines in our businesses, which really isn't unusual in an inflationary cycle like we're experiencing. But our pricing philosophy in the other segments is basically the same. When we see raw materials inflate, we pass the increases through the market in the form of these price increases. And the difference, in some cases, in timing between the businesses, we're going to work with our customers to pass the raw material costs through in a matter that is least disruptive to their businesses. But we're out there working every day, very hard, to ensure that our customers are successful. And these discussions are going very well. We're working with our customers in a way that allows them to absorb that, but we also are very firm in our need to get the price increase.

Chris, I would just add, on Valspar, as we talked about on our second quarter call, Valspar had not gotten a [outward] price in the first half of the year. We talked about the 6- to 9-month lag that typically occurs in those businesses. And we -- as John mentioned, we're out with price, but we saw minimal impact on price in our third quarter as it relates to Valspar.

Great. And maybe just touching on the Consumer Brands a little bit. Can you talk -- you mentioned in your Paint Stores Group, DIY volumes were up high single digits. How did they fare out in the Consumer Brands division, maybe specifically in the big box retailer? And any other commentary you could give on how that, maybe, division shaping up would be helpful.

Yes. So first, if you look at that business, it's a business made, up as you would expect, of a number of different pieces and parts. And when sales were down, we mentioned that there were a number of elements or drivers behind the softness that we experienced. And so as you would expect, there's a number of drivers here that are leading the improved performance that we've had here. Most notably, I would say, would be our European business. In the past, we talked about that business. It was down in the high teens through the first half, and that declined to mid-single digits here in the third quarter. Some of this improvement would clearly be that we have a more favorable currency comparison. But I'd also say that our order volumes were better in the third quarter than the first half as well. Our national accounts business here, which is the largest customers segment that we have here, those would be the home centers, national hardware, other big box format, was essentially flat year-over-year in the quarter. That would suggest inventory adjustments by some of our larger customers were less prevalent here in this quarter that we're just coming through. And while these signs are encouraging, as you would expect, we have higher expectations from our team. And while we are pleased with the momentum, we've got confidence in this team, the leadership that we're going to continue to see momentum. And that's what we're focused on. It's making our customers more successful with what they're trying to do.

The next question is coming from the line of Ghansham Panjabi with Baird.

I guess, sticking with the raw material theme, I know it's early, but can you give us a sense of how your raw material cost basket is tracking for '18 based on what you know at current?

Ghansham, this is Bob. We normally give the 2018 raw material outlook at the end of the year simply because our vantage point is better at year-end. And that's particularly true here. And the reason being that, as you all know, Hurricane Harvey disrupted a meaningful amount of the global chemical supply sector. And that caused some short-term shortages and tightness in a lot of the feedstocks. The fact of the matter is, at this stage, we don't know what short term means. And moreover, there are some things we do know. We know that the availability of a lot of the monomers are improving, but MMA in particular continues to be tight and is likely to be tight through 2018. We know that the global TiO2 market remains tight, and that has facilitated price increase announcement in second -- in late second quarter, early third quarter, and again for fourth quarter. They captured a fair amount of the 2Q, 3Q increase. We don't -- we're somewhat skeptical of their ability to capture the fourth quarter, but whatever they capture in second quarter, third quarter, obviously, is going to carry into 2018. But the big question is, how much of the impact -- the short-term impact of the storms on the petrochemical sector are going to carry over into 2018? And we just don't know that yet. We think the raw material basket at this point is tracking year-over-year in about the 6% to 6.5% range. And if you assumed that raw materials were stable from here through 2018, that would put you in the low to mid-single-digit inflation range.

Okay, that's very helpful. And then just as my second question. The $0.26 you called out for transaction and integration costs for the third quarter, where does that specifically flow through on a segment income basis? And then also, at the Analyst Day, you called out $2.7 billion in EBITDA pro forma for fiscal year '16. What does that number looks like for fiscal year '17 if you exclude the transaction and integration costs?

So the impact on the acquisition costs are flowing through admin, which should be about $187 million of that. And the rest, the amortization inventory step-up that Jane talked about, would be in the Performance Coatings Group and the Consumer Brands Group. When you talk about the EBITDA, and looking out, the $2.6 billion, which was the combined entity, if I look at core Sherwin, you're looking at an EBITDA of over $2 billion, $2.1 billion, $2.2 billion. Valspar historically has run about $630 million. So the $2 billion, plus the $600 million gets you to $2.6 billion. And right now, obviously, I think that you can understand we're running a little bit behind that for partial year, 7 years. But in 2018, you'd expect us to pick that back up as the price increases that John talked about take effect and as the synergies flow through. And like I said, we'll give you an update on '18 synergies on our year-end call.

Our next question is coming from the line of Don Carson with Susquehanna Financial.

John, you mentioned that you've maintained the midpoint of your guidance flat at $15. But obviously, that's after a $0.35 hit from the storms in Q3, and I assume some hit in Q4 as well. So I guess, versus where you were on your second quarter call, what's gone better than expected to offset or more than offset that storm impact?

Yes, Don, I think we'd start with the sales momentum we saw in our U.S. and Canada paint stores. As we talked about in July and August, coming out of July and August, we were running comp stores at 6.7%. And as John talked about, coming out of the storms, we see that momentum continue, along with the price increase that stores implemented. And the effectiveness we're seeing then on October -- from October 1 is helping that. And then, obviously, John -- or Don, with the 22% increase on core, that tells you that we're expecting gross margins to improve sequentially, third quarter to fourth quarter. So really, that's really what's driving our guidance and why we feel strong about it.

Okay. Then just to clarify, in Paint Stores Group, you said, John, that price was about 2.5% of that 5.2% same-store sales growth. What is it on a year-to-date basis? And how should that price unfold with the second initiative that you had, another 3% to 5% increase on October 1?

Yes, so it's around the 2 to -- maybe sneaking up to 2.5, Don, but probably closer to 2. And we expect the rollout in this recently announced price increase to be very similar to what we've just experienced.

Our next question is coming from the line of Steve Byrne with Bank of America Merrill Lynch.

A couple of questions on the Consumer Brands segment. Would you say you have more potential to push price in these legacy Valspar brands than in legacy Sherwin brands? And then in Lowe's, what can you offer them to maintain that combined shelf space of the Sherwin and Valspar brands? Does it need to be rationalized? And what do you do to avoid shelf space shift to a competitor?

Yes. So, Steve, what we look at constantly is the -- our ability to help our customers meet their goals, as I mentioned earlier. And so when you ask what is it that we might do, it's helping our customers to be more successful. We're having discussions with them on a regular basis, not just Lowe's, but every customer that we have. That's our path to success, is making our customers successful. Regarding price, we don't talk about price outside of our own stores. We have discussed the fact that we have clearly seen the raw material basket move. And so that we're out talking with customers in all segments of our business about the need to push pricing in. But we're not going to talk about any pricing in any specific customer. But going back to your point of what is it that we do with our customers, Lowe's or any other customer that we have on that side of the business, it's to help them be successful.

And do you have aspirations to penetrate the other big box retailer out there?

Well, again, we have discussions with our customers on a regular basis. We're not going to talk about any one customer. But our goal is to clearly understand what our customers' expectations are. We've got terrific brands, products, people and services. And if we can help demonstrate to them an ability to help them reach their goal, then we hope that we're rewarded.

The next question is coming from the line of Chris Parkinson with Crédit Suisse.

Can you just talk a little more about the regional housing trends you saw in PSG, especially as it appears some other regions offset some of the September weakness in Texas and the Southeast? And then you've seen a few housing markets with lower short-term availability but some higher prices. Can you just reconcile your own views on home prices versus turnover trends?

Yes, Chris, this is Bob. I would say that despite the fact that turnover has been slow due to lack of available inventory, remodeling has been very strong. I mentioned at our Financial Community Presentation that as much as 20% of the residential repaint has historically been driven by existing home turnover. We don't think that's true at this point in this cycle. We think a higher share of the remodeling activity is being done by stay-in-place homeowners and driven, at least in part, by rapidly rising home equity. So while we'd like to see more inventory available, we'd like to see stronger turnover. It doesn't seem to be dampening the rate of residential remodel and repaint activity. On the new residential side, it's been a really pretty strong story despite the fact that there are constraints to the market in labor and land availability. Single-family starts are up about 9% year-to-date, and completions are up a little more than that. New-home sales are up high single digits. And the homebuilder orders, at least as of second quarter, were into the double-digit. So the new residential market of which we have substantial share is driving significant growth. Even in nonresidential, and I know you didn't ask about that, but nonresidential, we've been seeing mid- to upper single-digit growth in starts, in square footage under construction and a little stronger than that in completions. So all of the drivers of our Paint Stores Group Pro business appear to be, I wouldn't say firing on all cylinders, but certainly, strong enough to drive the kind of volume growth that we're seeing.

Great. And just a quick follow-up. There's certainly been a little bit of optimism within some, let's say, key general industrial parallels within the legacy Val portfolio. Have you actually seen some improvements? Or would just characterize yourselves as still cautiously optimistic?

Are you talking about [Val] general industrial?

Correct.

Yes, I'd say we are very positive. Our team -- our leaders that lead that team have really been very bullish about, not only that core Valspar business, but the sales synergies of those 2 businesses coming together are really exciting. So yes, I'd say we're feeling bullish.

The next question is coming from the line of Vincent Andrews of Morgan Stanley.

Maybe just following up on that and just looking at the Performance Coatings Group. Your Sherwin profit was down a lot this quarter, and your sales aren't growing as fast as they are, obviously, at Valspar. So you talked about the synergies between the 2 businesses and some issues there. But what's it going to take to get the margins in better shape? I assume a lot of that is raw materials.

Yes, it is raw material. And so pricing is going to be an issue. If you look at our year-to-date margins, they're much more respectable. We had some pressure in the third quarter. And as we talked about, while we don't call out specifics with any specific customers, I would tell you that this is an area where our raw materials have moved, and we're now talking to our customers to get the increase. But as Al mentioned earlier, and I think it was Jeff Zekauskas's question regarding volume of the Valspar and our core businesses. Our volume in this business is very good. It would be a different story if we had volume screaming the other way. But we've got volume. We just need to be able to get the price to offset the raw materials. And we're feeling good about our ability to do that. As I mentioned, the discussions have largely taken place. It's a matter of timing before we start to receive them.

And the maybe it's just -- it's small for both companies, but the auto refinish business, there's been some noise out there amongst the competitive set, just challenge with distributors and pricing issues. Is there anything unusual going on in your business (inaudible) that business core?

Yes, I don't -- I wouldn't call that out in any negative way at all. We're out having pricing discussion there. We're working hard again to help our customers be successful. I don't think there's anything I'd call out that's unique about that business right now.

Our next question is coming from the line of Mike Harrison with Seaport Global Securities.

In the Paint Stores Group, if I take your 6.5% number for July and August and then look at the overall performance for the quarter, it looks like September may have been a 2% to 3% same-store sales growth month overall. Is that about right? And can you walk through what those same-store sales numbers look like across the different U.S. regions or North American regions in the month of September?

Well, I'd say directionally, you're heading in the right direction. And I don't know that we give specific numbers by region, Mike, but I'd say that if you back out the storms, our southeast, southwest divisions have really been lighting it up, a little bit of competition between the 2 of those to see who can lead the race. But all of our divisions, including Canada, all of them are doing very well. When you look at the progress that we're making, now we talked about this last year when we were coming out of the second quarter, that we are really focused in on new account activity and on share of wallet penetration. And I know we talked about this when we were together, that, that's really been a focus. And we are absolutely witnessing the benefit of this program. Our leadership teams there and our teams in the field are really executing, and we're feeling really good. So I wouldn't call out any one division as lagging outside of the storm impact.

All right. And then you mentioned the residential repaint business up double-digits. Does this mean that contractors have been able to add some labor and expand their capacity during the high season? And then what does that mean for the same-store sales growth as we get into the low season or the slower season where we have kind of seen better same-store sales growth over the past couple of years in the Q4, Q1 quarters?

Yes. So the momentum that you've talked about, I believe this will be the 15th quarter of double-digit gains in the residential repaint. And so we are continuing to capture, we believe, a little more than our share. I lost the last part of your question, though.

On the lower ends of our sales curve. So Mike, I think what you're going to see is that you saw it in our first quarter, we had a 7.5% comp on top of a 9.4% comp in the first quarter of '16. And as our guidance suggests, mid- to high single-digits will tell you that our U.S. Paint Stores have to be in the high end of that range on top of a 5.5% comp last year. So we definitely are seeing higher percentage increases in our off quarters, if you will.

The next question is coming from the line of John Roberts with UBS.

As we model the cash flow, the capital spending was only $60 million in the quarter. That annualizes, I think, to a much lower rate than either pro forma or where your target is on an annual basis. Could you comment about why it was so low and maybe what the next couple of quarters look like or next year?

Yes, John, I think our CapEx for this year will be about $200 million, $210 million. And what you see is, it is a little bit lower run rate as we get to the facilities and understand more about what they're doing, their capacity utilizations. We talked about having capacity utilization and architectural in the Valspar sites. So you won't see us spending capital for capacity expansion that maybe we have over the last few quarters. I'd say we're really working on 2018's plan, and we'll give you an update at our year-end call. But I still think we're going to be in the target of 1.6% to 2%, is still a good target. And like I said, we're working on the '18 plan, and we'll give you an update.

And then in the back, in the reconciling slides, you've got the operating segment comparison. And Valspar coatings was up 8.5% year-over-year in there. Some things must have been up double digits. I don't know if that was packaging coatings or coil coatings, any of the major areas of double-digit in that Valspar Coatings segment?

Yes, we saw some nice progress in general industrial. John talked about the bullish outlook we saw. Also some nice movement in our industrial wood business, and that's specifically in Asia. So yes, we, across the board, we saw increases, but those would be the ones that kind of led the way.

The wood business, it was certainly strong in Asia. But having just spent some time with our wood team at the market here, I'd say we're starting to see some nice progress in a number of parts of the world, not only Asia, there's some good momentum there.

Our next question is coming from the line of Scott Rednor with Zelman & Associates.

I wanted to ask about DIY within the stores. I think you called out high single digits, John. And I think that's the strongest DIY number you've turned in, in 4 or 5 quarters. So is there anything unique there? Or just curious, if you could elaborate.

Scott, actually, if you look at the performance that we had in DIY throughout -- actually, through 2016, we were in the mid-single digits throughout the quarter. First quarter this year, we were up mid-single digits. It was actually the second quarter of this year, we were actually flat second quarter. And then as you mentioned here in the third quarter, the high single digits. Some interesting parts there. We're always trying to keep our fingers on the pulse, to know exactly how the consumer's acting and why. And I wish I were smart enough to know exactly why there are. But we do know that there's some economic factors that might drive homeowners to hire a painting contractor. We talked about those. Those could be driving the same thought process into driving consumers into a specialty paint store where they want a high-quality finish, and they may not want to reach all the way to have a painting contractor do the work, but they want to try to get as close to the finish as possible and so they're turning to a specialty store like ours, where the quality of products and services will help them reach that.

And Scott, I would just add to that, that the real difference between the mid-single digit growth that we saw all last year and the upper single-digit growth we saw in the third quarter was price. The volume growth was pretty consistent.

And Bob, just also on the PNM piece that flows through the Paint Stores. Is that now trending positively?

Yes, it actually is. In fact, we've commented that we'd saw -- we've seen that business go positive early in the year in the first and second quarter. It continues to show -- to build momentum through the third quarter. Our third quarter was stronger than second quarter. We credit that to both our success in, as we call, the pivoting to key markets that are showing growth like bridge and highway, water and wastewater and some of the others and improving conditions in the end markets that have been in steep decline, particularly oil and gas. And I should point out that our protected marine business was also positive in Latin America in the third quarter.

And then just quickly, Al, what are you taxing the amortization and integration costs at? I assume it's a little bit higher than the tax rate across the entity.

Yes. It's about 30%.

The next question is coming from the line of Dmitry Silversteyn with Longbow Research.

All my questions have been answered, but you guys have expanded your presence outside of the U.S. So maybe it's worth revisiting what the foreign exchange impact has been on revenue, both in the Latin American group as well as in the Consumer Brands and the Performance Coatings. I'm assuming there is not much change in the Canadian dollar, so there shouldn't be much of an impact on the Paint Stores Group.

Yes, Dmitry, you're correct. It's very -- it's minimal across tag. It's really basically flat or not -- no impact on Latin America. And we had a 1.5% tailwind in Performance Coatings.

Okay, okay, so that's helpful. And in the Consumer Group, there was not -- that it was also flattish?

Yes, really no impact.

Because I know you've picked up some Australian and Chinese and U.K. business with Valspar, so.

Yes, the impact on consumer brands was really related to the devaluation of the pound related to Brexit, and we've annualized that. So in the quarter, there's really been no impact on consumer brand.

Got it, got it. Okay. If you look at your Latin American profitability, it's kind of been all over the place. And I'm just wondering, in both in interest of understanding what's going on in the business and in sort of forward forecasting, how much of that profit variability has been a function of volatile foreign exchange, where you just -- you price a product and then the currency moves on you? Or how much of it has been, sort of either difficulty in growing the business or, perhaps, raw material inflation that was outsized for some period? It's just, there just doesn't seem to be a lot of rhyme or reason to the quarterly performance on the margin side of that business.

Yes, Dmitry. It's largely, to your point, been impacted by the raw material cost. We've had TiO2 coming in from Asia that has spiked up. So when you would expect to have some benefit, maybe from an FX standpoint, you get the impact of rising raw material costs coming in into the market as all products coming in there, for the most part, have come in at higher price this year. So that's largely been the impact.

Okay. So if I'm looking at sort of the profitability of that business, quarter-to-quarter, you seem to put up kind of positive profit margins for most quarters. But then you had a big 9% decline or so, or 9% negative margin in the second quarter of this year, which corresponded to about a 7% decline in -- or 7% negative margin in the second quarter of last year. So is that just a second quarter thing that, that you would put up a negative margin, even a good year?

No, we don't...

(inaudible) a lot of negative things.

No, I think, Dmitry, you definitely -- as specifically, Brazil, which is over half of our business, and the economic issues they've had, as it continues to get better, we will see choppiness in our quarters. But our expectation is that we will continue to improve over the midterm, certainly, and get this business back to profitability on a more consistent basis, so you don't see these quarter-to-quarter swings.

Got it, got it. Okay, that's helpful. And then final question on the -- I know you guys can't talk about it explicitly, but PPG did say on their call that they're working with their big box partners to try to move pricing, given what's going on with raw materials now for the second year in a row. Is that something that I'm assuming you have the same initiative, and we should start thinking about, perhaps, a little bit of a positive price in the DIY channel, not just company-owned stores?

Yes, Dmitry, I'd broaden it across the entire company. I've tried to be very clear with this, that, it's a very good question and one that we've tried to be as open as possible, and that is that, now we try every day to bring value to our customers. And when the raw material basket is moved like it has, we're in front of our customers talking about the need to stay whole in that, and that's across all customers, all segments.

The next question is coming from the line of Mike Sison with KeyBanc Capital Markets.

In terms of '17, you gave us core EPS with Valspar, an annualized base of $16, $16.57, your guidance to midpoint $15. What does that imply for EPS with Valspar and the whole for '17?

If I understood, Mike, you're talking about our full year guidance at $15 with Valspar. Valspar will contribute about $0.80 to that in the guidance. And then that tells you that our core or legacy Sherwin EPS at $14.20 would be up 10.5% compared to last year's $12.85. Did I answer your question correctly?

Well, I just -- relative to the $16.57, which you gave at the Analyst Day, which is annualizing Valspar for the full year, what does that number equate to for '17 based on your $15 guidance?

It's really hard to give you that number based on guidance when you're talking about all the puts and takes and the impact that Valspar has on pricing and the raw material inflation. So what I would tell you, Mike is that, we'll give you an update for the full year '18 with Valspar, and we can kind of give you an impact, certainly, the interest expense on the new debt impact. So it's hard to get a comparable '17 versus '16.

Okay, and then just a quick question here in terms of price increases. Does that cover potential inflation that you may see in 2018?

Well, it's certainly based on what we believe to protect us through 2018. But we're as determined as we can to get it right, but we don't necessarily always know the future. I'd say that we don't feel as though we're in a similar market to what we experienced in 2010 through 2012, where if you'll recall, we were out with 6 price increases in 22 months. So we're going in with what we believe will cover us, but I think we've demonstrated through our past practices the conviction and determination to protect our shareholders.

I do think it's also important to point out that we were out communicating about our October 1 price increase with our customers before Hurricane Harvey made landfall. So the impact on the petrochemical sector of the hurricanes that hit at the end of August, in early September, were not contemplated in that price increase. But as I indicated earlier, we think a lot of that, the cost increase as a result will be short-term in nature, and we'll just have to see how '18 unfolds.

Our next question is coming from the line of Scott Mushkin with Wolfe Research.

A lot of my questions actually have been answered, but I wanted to broaden it out a little bit. At the Analyst Day, you guys were really pretty bullish about the outlook. And I just wanted -- didn't take out -- obviously took place not that long ago. But I just want to see, kind of gauge your temperature about a month later and see are you're still feeling as bullish in general about your business and the outlook going forward. And then -- and I'm suspecting the answer is yes. But -- and then as you look at it and again, over the next year or 2 as you bring these 2 companies together, what's your biggest concern, both, I guess, from a macro perspective and then also internally to the things we trip up. So it's kind of 2-part question there.

Yes, Scott, so I'd say nothing has changed about our view of the world. And any bullishness that you felt continues. And we feel -- I'd say it this way, that we're more bullish than ever on this deal, from both a strategic standpoint and from a synergy standpoint. This transaction is value-creating on many levels, and we're thrilled with where we are, we're thrilled with the people, we're thrilled with the products and, most importantly, we are thrilled with the customers. So, we're very excited about where we are and where we're going. The second part of your question was concerns and what might...

Yes, not even just with the deal, right, like the outlook looks really bullish. You're really bullish on the deal. As you guys looked out, what do you worry about, though, right? Is cost inflation that's your biggest worry? Is it -- so I guess I'm just trying to -- both with Valspar in mind, but also just in general.

Cost is something that we deal with. We don't like to deal with it, but as I just mentioned in the last call that I think we've demonstrated an ability to put price in where we have to. I'd say it'd be macro shocks to the economy or some disruption of some sort that would really impact the economy on a larger scale. But right now, if you would speak to any leader inside our company, we've got a strong line of where we're going, what we're trying to do and a lot of determination to be able to do it. And that gives us confidence that we control our future, and we're focused on executing to be able to win.

The next question is coming from the line of P.J. Juvekar with Citi.

We know that the DIY market is weak. Are the big boxes trying to get in more contractors in the stores? And are you seeing more competition from that side? And then you talked about the shortage of contractors in the U.S. the last couple of years. Are you guys doing anything proactively to address that issue?

So I'd say first to your question about the home centers activity into the Pro business. I'd say that, that's always been an element of the market and one that we respect. I'd say that with our customers and the focus that they have on subsegment of that Pro business, where we can help them, we are determined to help them do that. In many cases, those are remodelers that are not typically in our stores, and if we can help our customers to grow that business, we want to try to help them. The...

On the labor shortage.

On the labor shortage, it's interesting. The largest percentage of the business that feels the labor restriction is in the new residential, commercial, industrial business. Some in the residential repaint, but again, given our 15 quarters of double-digit gains, I'd say that many of our customers are finding a way to find the labor that they need. In those other areas, while we've been working with a number of areas to try to generate more supply of labor, the reality is, is that if in fact, we were successful, and we could find painting contractors or labors that could help our painting contractors, in many cases, they would still be on the job waiting, waiting for the drywallers to finish, the roofers to finish, I mean, electrical. I mean, it's a much more macro issue than just the painting contractors themselves, a much larger issue. And so while we're trying to help in a meaningful way, it's a bigger issue than just the painting contractors.

I would add to that, that for decades, we've been helping contractors with labor issues by creating products that make them more productive. And it has been the focus of our R&D effort for a long time, is to get contractors on and off the job faster. That also helps in cycles where they are labor-constrained. Using more productive products and formulas can help them do more jobs in less time.

As well as less of a requirement to come back, touch up better or be more consistent in what they're trying to do to help them get off the job quicker as well. So efficiency and stay off the job, so it's a good point, though.

And just lastly, how much benefit could you possibly see in 2018 if from all the reconstruction that would take place in Texas, Florida and Puerto Rico, which are all your core markets?

Well, it's really hard to quantify that. Different types of storms in different areas were affected in different ways. In Florida, where we really took a substantial hit in the number of stores that were closed, there was some flooding. And in some areas, we don't want to minimize this at all. I mean, we're -- our hearts go out to those that are affected by the storm. Fortunately, many of the areas were impacted with some water damage that could be fixed relatively quickly. And then there were others that were significantly and more horrifically damaged, and those will be a longer-term cycle to get back up. In Texas and in Puerto Rico, there was more damage, a smaller market while those areas will build themselves back up, and we want to help those communities, our employees and those that live in that area, it's not going to be significant enough to move the needle. And so we're going to be there to help in any way we can, but we don't think that, that's going to be something that's going to really drive our results.

The next question is coming from the line of Eric Bosshard with Cleveland Research Company.

On the consumer segment, I appreciate the progress and growth or results in 3Q relative to 2Q, but thinking about the path forward for growth in that business, and I heard the comments on some efforts on price, but what are you doing and what should we be thinking about in regards to the growth out of that piece of the business?

Yes, so Eric, as you would expect, we're engaged with our customers. That's not something that we lay out typically in a call like this. What you should expect is that those dialogue -- those discussions take place regularly. We've got, we believe, a terrific assortment of technologies, people and services to help our customers win. But from a strategic standpoint, we don't want to lay those out here today.

In terms of the destination with growth, is there a goal or a focus...

Eric, I'm sorry, I can't hear you.

Yes, sorry. In terms of the destination with growth in that business, can you give us a little bit more there? I understand the strategic piece of it, but in terms of what growth out of that business are you looking to get back to on a sustainable basis?

Yes, I'd say we've spoken that, that business could be a low single-digit growth run for us. And we feel we can capture that. And quite frankly, talking to our teams, our expectations are going to be higher than that. But we feel as though there's a lot that we can bring there. And we're really excited about the combined company and the assets, brands. I mean, there is a lot that we can accomplish, we think. There's a lot of institutional knowledge on both sides of our company now coming together that we're going to try to leverage.

But then secondly, and you talked about it a bit, but just the level of conviction on improving the performance coating margins through pricing. Again, I know you've only had this, the Valspar piece of the business for a period of time. But the confidence level of being able to make that happen as we go into 2018, where do you stand on that?

I'm not sure how to convey the conviction or confidence any higher than -- I mean, we're going to get that, Eric. We're out there having those discussions right now. We don't expect ever to just have something that we don't deserve. We're working hard. We're working hard to improve the quality, the availability, service, people, every element of that job, of our job there. And those discussions have taken place in many cases, and it's a matter of timing. There are some that continue in dialogue and discussions. But the largest part, those discussions are -- have been resolved. And as I mentioned, you should start to see some of that in the fourth quarter, but the lion's share of it coming in as we turn the year.

Our next question is coming from the line of Rosemarie Morbelli with Gabelli & Company.

I was wondering if you could talk about the trend in architectural paint and all the businesses you have in China following the 5-year big meeting by the heads of the country.

So we feel as though in China, we have a terrific platform to continue to grow, and perhaps even better leverage. We do feel as though the technology, as I've just mentioned, and I think that discussion may have been taken as a more North American-focused discussion. But when we're looking at this consumer business, we talk about all the markets that we participate in now. And so when you look at that market and a brand that we believe could be better leveraged, we're excited about supplying not only the technology that exists in our combined company around the world, but there's a lot of institutional knowledge that we want to bring to that market as well and to take advantage of the opportunities that exist in the market. Our market share there, well, I'll just say there are plenty of opportunities for us. And so we're working with our team to identify those assets that exist inside the company that can help them better perform in the market.

And then looking at Investor Day, you increased the synergy levels. And as you look at Valspar more closely, is there -- what is the likelihood that we will see one more bump in that particular projection? And will it take until the end of 2018? Or do you think that as you are getting your arms around all of the manufacturing facilities and what you can do, we could actually see it before year-end?

Yes, Rosemarie, for the full year, let me just start that we are -- we talked about seeing about $15 million going through our P&L. And we haven't come off that forecast. However, what you saw is an increase in our forecast for cost to achieve synergies in 2017, which, as John talked about in his comments, was the result of some facility closings we announced in our third quarter. We really won't see the benefit of those until late next year or early 2019. But I would tell you, we are going to increase our expected annual run rate synergies, at least for this year, to $160 million versus the $106 million that we had talked about at the end of our second quarter. You're probably going to have to wait until our year-end call to get an update on the $280 million run rate synergy that we talked about at the Financial Community Presentation.

And then lastly, if I may, could you help me allocate the charges between cost of goods and SG&A as a opposed to just some old pieces going into the different segments or an EPS basis?

So if you look at the cost to achieve and the acquisition purchase accounting costs, you would see, in the third quarter, about $87 million of that was in gross profit, primarily related to the inventory step-up. And then you saw the rest of it, or about $119 million, $120 million in SG&A related primarily to the amortization expense on the intangibles.

It appears we have no further questions at this time. And so I'd like to pass the floor back over to Mr. Wells for any additional concluding comments.

Thank you, Jesse. As always, I will be available over the next few days to answer any additional questions that arise as you digest this morning's call. If you'd like to be placed in the queue for a follow-up -- for a follow-up call, please call Kristy Johnson at (216) 566-3001, and she will add you to the call back queue. Again, that number is (216) 566-3001. I'd like to thank you again for joining us today and thanks for your continued interest in Sherwin-Williams.

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