The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of fourth quarter and full year 2018 results and the outlook for the full fiscal year of 2019. With us on today's call are John Marikis, President and CEO, Alma Sishin, 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 issue or 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 until Wednesday, February 20, 2019 at 5 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. After the company's prepared remarks, we will open the session to questions. I will now turn the call over to Bob Wells.

Thanks, Jessie. Good morning, everyone. Before discussing our results and outlook, I'd like to call your attention to the accounting change mentioned in our press release this morning. This voluntary inventory accounting change made in the fourth quarter of 2018 was driven by the company's integration activities. As a result of this accounting change, and in accordance with generally accepted accounting principles, a retrospective one-time expense adjustment to cost of goods sold of $58.9 million was or $0.47 per share, has been made resulting in revised GAAP 2017 fourth quarter and full year amounts. This revision increased acquisition-related costs and reduced previously reported segment profit for performance codings and consumers' brands groups by $35.7 million and $23.2 million, respectively, for both the fourth quarter and full year 2017 compared to what was previously reported. To be clear, there was no impact on fourth quarter or full year 2018 from this revision. We've summarized fourth quarter and full year adjustments to operating segment profit in a slide deck on our website under January 31st 2018 year-end and fourth quarter financial results. With that, let me move on to our fourth quarter and full year 2018 results. All comparisons in my remarks are to the revised fourth quarter and full year 2017, unless otherwise stated. Beginning with fourth quarter 2018, consolidated sales increased $84.7 million, or 2.1%, to $4.06 billion. For the full year 2018, consolidated sales increased $2.55 billion, or 17%, to $17.53 billion. As a reminder, the Valspar transaction closed on June 1, 2017. Incremental Valspar sales from January through May of 2018 increased increased consolidated sales by 12.4% for the year. Organic growth for full year was 4.7%. Consolidated gross profit dollars in the fourth quarter decreased 56.6 million, or 3.3%, to $1.68 billion. Gross profit for the year increased 699.8 million, or 10.4%, to $7.4 billion. Consolidated gross margin in the fourth quarter decreased to 41.4 percent from 43.7 percent in the same period last year. Excluding impacts from purchase accounting and one-time items, consolidated gross margin in the quarter was 42.4 percent compared to 44.7 percent in 2017. Consolidated gross margin in the year decreased to 42.3% from 44.8% in the same period last year. Excluding impacts from purchase accounting and one-time items, consolidated gross margin for the full year was 42.8% compared to 45.9% in 2017. Selling general and administrative expense decreased $87.2 million, or 6.6%, to $1.24 billion in the fourth quarter, and also decreased as a percent of sales to 30.5% from 33.3% in the same quarter last year. SG&A expense for the year increased $236.1 million, or 3.5%, to $5.03 billion, but decreased as a percent of sales to 28.7% from 32% in 2017. Interest expense for the quarter was essentially flat year over year at $89.4 million. For the year, interest expense increased $103.3 million to $366.7 million, The increase was primarily due to a full year of Valspar-related debt compared to seven months last year. Consolidated profit before tax in the fourth quarter decreased $124 million, or 54.9%, to $102 million. The fourth quarter of 2018 included non-operating expenses of $135.9 million related to environmental remediation and $37.6 million related to a pension plan settlement as described in our press release. For the full year, consolidated profit before tax decreased $109.7 million, or 7.5%, to $1.36 billion. Full year 2018 results included non-operating expenses of $167.2 million, $37.6 million, and $136.3 million related to environmental remediation, pension plan settlement, and California public nuisance litigation, respectively. Excluding acquisition and non-operating expenses, our effective tax rate on adjusted income for the quarter was 19.1% and 19.5% for the full year. Diluted net income per common share for the fourth quarter, 2018, decreased to $1.07 per share from $8.92 per share last year. The $1.07 per share in the fourth quarter includes non-operating expenses of $1.37 per share and acquisition-related expenses of $1.10 per share. The $8.92 per share in the fourth quarter of 2017 includes a one-time benefit of $7 per share from deferred income tax reductions and $1.24 per share in acquisition-related expenses. Excluding these items, adjusted diluted earnings per common share is increased 12% to $3.54 in the fourth quarter 2018 from $3.16 in the fourth quarter 2017. Diluted net income per common share for the full year decreased to $11.67 per share from $18.20 per share in 2017. The $11.67 per share includes non-operating expenses, of $2.71 per share and acquisition-related expenses of $4.15 per share. The $18.20 per share from last year includes a $0.44 charge related to discontinued operations, acquisition-related expenses of $3.47 per share, and a one-time benefit of $7.04 per share from deferred income tax reductions. Excluding these items, adjusted diluted earnings per share increased 23% to $18.53 in full year 2018 compared to $15.07 in full year 2017. We have summarized the fourth quarter and year-over-year earnings per share comparison in a Regulation G reconciliation table at the end of our fourth quarter 2018 press release. Let me take a few minutes to break down our performance by segment. Sales for the Americas Group in the fourth quarter increased $65.4 million, or 3%, to $2.25 billion. For the year, net sales increased $507.9 million, or 5.6%, to $9.63 billion. Currency translation rate changes reduced sales in the quarter and the year by 1.8% and 1%, respectively. Comparable store sales in the U.S., Canada, and the Caribbean, that is, sales by stores open more than 12 calendar months, increased 2.9% in the quarter and 5.1% in the year. Regionally, in the fourth quarter, our Southeast Division led all divisions, followed by Midwest, Eastern, Southwest, and Canada. Sales were positive in every division in the quarter. Fourth quarter segment profit increased $7.4 million, or 1.8%, to $413.4 million. Currency translation rate changes decreased segment profit 2.7% in the quarter. Full-year segment profit increased $128.9 million, or 7.3%, to $1.9 billion. Fourth quarter segment operating margin decreased 20 basis points to 18.3%, from 18.5% last year. Full-year segment operating margin increased 30 basis points to 19.7% from 19.4% last year. Turning now to the consumer brands group, fourth quarter sales decreased $37.2 million, or 6.5%, to $534.4 million. the new revenue recognition standard reduced sales by 2.8% in the quarter. Full-year sales increased $584.3 million, or 27.1%, to $2.74 billion. Excluding the incremental five-month sales from Valspar, sales for the group increased 0.2% in the year, The new revenue recognition standard reduced sales by 4.8% in the year. Fourth quarter segment profit increased $11.6 million to $12 million. Purchase accounting costs decreased segment profit by $24.5 million compared to $32.8 million in the fourth quarter 2017. In addition, The accounting change decreased segment profit by $23.2 million in the quarter in 2017. Full-year segment profit increased $58.3 million, or 28.7%, to $261.1 million. Segment profit from the incremental five months of Valspar results was $75.8 million. Purchase accounting costs decreased segment profit by $110.9 million compared to $107.6 million in the year 2017. In addition, the accounting change decreased segment profit by $23.2 million in full year 2017. Fourth quarter segment operating margin increased to 2.2% from 0.1% last year. Excluding the purchase accounting expenses in both quarters and the accounting change in the fourth quarter 2017, segment operating margin decreased 6.8% in the fourth quarter 2018 from 9.7% in the fourth quarter 2017. Full-year consumer group segment operating margin increased to 9.5% from 9.4% last year. Excluding the purchase accounting expense in both years and the accounting change in 2017, segment operating margin decreased to 13.6% in 2018 from 15.5% in 2017. As a reminder, consumer brand segment also incurred approximately $50 million in expenses this year to support the launch of the exclusive partnership with Lowe's, and $20 million in incremental supply chain costs, which we described in our third quarter results. For our performance codings group, fourth quarter sales increased $56.5 million, or 4.6%, to $1.27 billion. Currency translation rate changes reduced fourth quarter sales by 1.2%. For full-year sales, increased $1.46 billion, or 39.4%, to $5.17 billion. Excluding the incremental five-month sales from Valspar, sales for the group increased 5.1% in the year. Fourth quarter segment profit increased $28.6 million, or 34.1%, to $112.3 million. Purchase accounting costs decreased segment profit by $55.2 million compared to $42.1 million in the fourth quarter 2017. In addition, the accounting change decreased segment profit by $35.7 million in the fourth quarter 2017. Full-year segment profit increased $189.3 million, or 72%, to $452.1 million. Currency translation decreased segment profit by 1.7% in the year, and segment profit from the incremental five months of Valspar results was $97.6 million. Purchase accounting costs decreased segment profit by $215.8 million compared to $183.1 million in 2017. In addition, the accounting change decreased segment profit by $35.7 million in 2017. Fourth quarter performance group segment operating margin increased to 8.8% from 6.9% last year. Excluding the purchase accounting expense in both quarters and the accounting change in the fourth quarter 2017, segment operating margin was flat year-over-year at 13.1% in the fourth quarter. Full-year segment operating margin increased to 8.8% from 7.1% last year. Excluding the purchase accounting expense in both years and the accounting change in 2017, segment operating margin decreased to 12.9% in the year from 13 percent in 2017. That concludes our review of our operating results for the fourth quarter, so let me turn the call over to John Marikas, who will make some general comments and provide our outlook for fiscal year 2019. John? John Marikas Thank you, Bob.

Good morning, everyone. Thanks for joining us. I'd like to make just a few additional comments on our fourth quarter and full year 2018 before moving on to our outlook for 2019. Our fourth quarter results that Bob just walked through fell short of our original expectations, with a shortfall in revenue growth driving the majority of the weaker than anticipated results. We often view trends in the fourth quarter as indicative of the momentum we will carry into the following year. In this case, the improving cadence of our business late in the fourth quarter was encouraging, and January has given us a solid start to the first quarter. In terms of the full year, 2018 was a record year for Sherwin-Williams by many measures. Sales and adjusted earnings per share were both records. Sales increased 17 percent to $17.5 billion compared to the prior year, or 4.7 percent, excluding the five-month contribution from Valspar. Adjusted earnings per share increased by approximately 23 percent. Adjusted EBITDA, or earnings before interest, taxes, depreciation, and amortization increased to $2.82 billion. Net operating cash for the year was a record $2.04 billion, an increase of more than $151 million compared to 2017, and 11.6% of sales. Free cash flow, which we define as net operating cash, less CapEx and dividends, was $1.46 billion compared to $1.34 billion last year. All of our operating segments contributed to this record performance. Within the Americas group, full-year sales increased 5.6% against a challenging prior year comparison of 8.8%. Residential repaint remained our strongest customer segment in the year, up by a double-digit percentage. All other segments were positive for the year. Full-year segment profit dollars and margin also improved year over year. We continued to invest in innovation and service, introducing 25 new products, our eighth consecutive year of double-digit product introductions. We opened 87 net new paint stores in the U.S. and Canada and added 150 new sales territories. In the consumer segment, full-year sales were up mid-single digits, excluding the five months' incremental sales from Valspar and the impact of the new revenue standards. Adjusted segment margin was down year over year, driven mainly by expenses related to a new customer program and raw material cost increases, not all of which were anticipated. We feel very good about our product reset, merchandising, and training efforts with Lowe's this year, as well as our strengthened relationship with other key retailers. Performance coatings group sales across all product categories were positive, led by General Industrial and Packaging, which were both up by double-digit percentages. Throughout the year, Performance Coatings Group combated persistent raw material inflation with price increases, some of which are still flowing in. This group also made commendable progress on continuing integration efforts. Company-wide, we delivered approximately $180 million in synergy benefit to the P&L in 2018, about $30 million above the midpoint of our expectations at the start of the year. We exited the year at a synergy run rate of approximately $360 million. Finally, we returned approximately $936 million to shareholders during the year, including $323 million paid in cash dividends and $613 million to purchase 1.52 million shares of common stock. and we reduced our debt by $1.1 billion. Let me begin my comments on our outlook for first quarter and full year 2019 by saying that we remain confident in the sustainability of demand across most of our end markets. I'm also confident in our ability to execute on the key initiatives that drive our success in the short and long term, and in our ability to deliver value to our customers. We entered 2019 well-positioned and focused on what we can control. I'm less confident about the increasing number of economic, political, and social variables that are beyond our control. These would include government shutdowns, Fed rate hikes, tariffs, trade wars, immigration, and security, to name a few, any one of which could disrupt market demand and raw material supply. While it's our job to focus on those things we can control and adapt to those things we cannot, these factors individually and collectively create uncertainty and expand the range of potential outcomes. For the first quarter of 2019, we anticipate our consolidated net sales will increase two to 6% compared to the first quarter of 2018. The first quarter of 2019 will include expenses related to the defined benefit plan annuity purchase of approximately 43 cents per share. As we described in our call two weeks ago, demand in our North American paint stores inflected upward in December and continued to accelerate in January. We're encouraged by this, but remind you that January is a small month, with March being the most critical month in the quarter. For the full year 2019, we expect core net sales to increase 4% to 7% compared to full year 2018. On an earnings per share basis, we believe the most meaningful way to provide guidance is to exclude Valspar acquisition costs and one-time items. On this basis, and given our sales outlook, we expect adjusted 2019 full-year diluted net income per common share to be in the range of $20.40 to $21.40 per share, an increase of approximately 13%. at the midpoint compared to the 1853 reported last year on a comparable basis. This adjusted 2019 guidance excludes approximately $3.20 per share for acquisition-related expenses and 43 cents for other non-operating expenses. We've included a Regulation G reconciliation table with this morning's press release to better illustrate all the moving parts. We expect our 2019 effective tax rate to be in the low 20% range. One key assumption embedded in this outlook is that raw material inflation for 2019 will be in the low single digits compared to 2018. The rate of year-over-year inflation will be highest in the first quarter, and assuming stable petrochemical feedstocks and no supply disruptions, should diminish as we go through the second half. A few additional data points may be helpful for modeling purposes. We expect incremental synergies of approximately $70 to $80 million in 2019, with a total annual run rate of approximately $415 million at year end. We expect capital expenditures to be approximately $320 million, which is about 1.7 percent of anticipated sales, as we continue to invest in capacity and productivity improvements, systems, and new stores. Depreciation should be $267 million, and amortization will be about $315 million. After focusing largely on debt reduction the last two years, we'll begin moving back toward our more traditional capital allocation philosophy in 2019. We expect to reduce debt by $600 million by the end of this year, which should reduce our net debt to EBITDA ratio to below three times by the end of 2019. Historically, we've targeted dividends at about 30 percent of prior year gap earnings. Next month, at our Board of Directors meeting, we will recommend a quarterly dividend increase of 31 percent to $1.13 per share, up from 86 cents last year. We expect to make open market purchases of company stock in 2019 at a level beyond what is necessary to offset dilution from options exercises. On December 31, We had remaining authorization to acquire approximately 10.13 million shares. We'll also continue to evaluate acquisitions that fit our strategy. Before moving on to your questions, let me wrap up today by asking you to save the date of Wednesday, June 5th on your calendars. That will be the day we'll host our annual financial community presentation at the Westin Hotel in Cleveland. The program will include presentations by several members of our leadership team. We'll host our customary Q&A session, followed by a reception and lunch. Again, that date is Wednesday, June 5th. We'll be sending out invitations and related information and a link to our registration site in April. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions.