The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of first quarter 2019 and the outlook for the second quarter and full fiscal year of 2019. With us on today's call are John Marakis, Chairman and CEO, Al Mestician, CFO, Jane Cronin, Senior Vice President, Corporate Controller, Bob Wells, Senior Vice President, Corporate Communications, and Jim Jay, Vice President, Investor Relations. This conference call is being webcast simultaneously in listen-only mode by issue 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 Friday, May 10, 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 summarizing our results for the quarter, I'd like to remind you that our annual financial community presentation is coming up on June 5th here in Cleveland, Ohio. Please contact me or Jim Jay to receive the registration link to this event. It's a great opportunity for you to meet and hear from our business unit management team, and we hope to see you all there. Moving on to our results for the first quarter. All comparisons in my remarks are to the first quarter of fiscal 2018, unless otherwise stated. Consolidated sales in the first quarter of 2019 increased $75.9 million, or 1.9%, to $4.04 billion. Consolidated gross profit dollars in the quarter increased $48.2 million, or 2.9%, to $1.74 billion. Consolidated gross margin in the first quarter increased to 42.9%, from 42.5% in the same period last year. Excluding impacts from purchase accounting, adjusted consolidated gross margin in the quarter was flat year over year at 43%. Selling general and administrative expense increased $29.5 million, or 2.4%, to $1.24 billion in the first quarter, and also increased as a percent of sales to 30.8% from 30.6% in the same quarter last year. Interest expense for the quarter was essentially flat at $91 million. Consolidated profit before tax in the first quarter decreased $4.7 million, or 1.6%, to $298.9 million. The first quarter of 2019 included non-operating expenses of $32.4 million, primarily related to a pension plan settlement as described in our press release and included in our previous guidance. Excluding acquisition-related costs and non-operating expenses, our effective tax rate on adjusted income for the quarter was 19.3%. Diluted net income per common share for the first quarter 2019 was flat compared to last year at $2.62 per share. Earnings per share in the first quarter of 2019 includes non-operating expenses of 27 cents per share and acquisition-related expenses of 71 cents per share. The $2.62 per share reported in the first quarter of 2018 included $0.95 per share in acquisition related expenses. Excluding these items from both years, adjusted diluted earnings per share increased to $3.60 in the first quarter of 2019 from $3.57 last year. We have summarized the first quarter earnings per share comparison in a Regulation G reconciliation table at the end of our press release. Let me take a few minutes to break down our performance by segment. Sales for the Americas Group in the first quarter increased $74.4 million, or 3.6%, to $2.15 billion. Unfavorable currency translation reduced sales in the quarter by 1.5%. Comparable store sales in the U.S. and Canada increased 3.6% in the quarter. Regionally in the first quarter, our Southeast Division led all divisions, followed by Eastern, Canada, Southwest, and Midwest. Sales were positive in every division in the quarter. First quarter segment profit decreased $6.3 million, or 1.9%, to $331.1 million. Currency translation rate changes decreased segment profit $4.5 million in the quarter. First quarter segment operating margin declined 80 basis points, to 15.4% from 16.2% last year. Turning now to the consumer brands group, first quarter sales decreased $1.9 million, or three-tenths of a percent, to $654.5 million, including the divestiture of the guardsman business. Sales from continuing operations excluding approximately $17 million in guardsmen revenues, increased 2.4% in the quarter. First quarter segment profit increased $13.7 million, or 18.5%, to $87.9 million. Purchase accounting costs decreased segment profit by $22.9 million, compared to $31.8 million in the first quarter 2018. First quarter segment operating margin increased to 13.4% from 11.3% last year. Excluding the purchase counting expenses in both quarters, adjusted segment operating margin increased to 16.9% in the first quarter 2019 from 16.2% in the first quarter last year. For our performance codings group, first quarter sales increased $3 million, or 0.3%, to $1.23 billion. Currency translation rate changes reduced first quarter sales by 3.9%. First quarter segment profit increased $7.9 million, or 8.7%, to $98.7 million. Unfavorable currency translation reduced segment profit $3.5 million in the quarter, and purchase accounting expense decreased segment profit by $54.1 million compared to $57.5 million in the first quarter of 2018. First quarter performance group segment operating margin increased to 8% from 7.4% last year. Excluding the purchase accounting expense in both quarters, segment operating margin increased to 12.4% in the first quarter 2019 compared to 12.1% in the first quarter last year. That concludes our review of operating results for the first quarter. So let me turn the call over to John Marikas, who will make some general comments on the first quarter and provide our outlook for second quarter and full year 2019. John?

Thank you. Good morning, everyone. Thanks for joining us. I'd like to make just a few additional comments on our first quarter before moving on to our outlook. First quarter volumes were a bit lighter than anticipated across all three segments. driving consolidated results to the lower end of our expectations range. We commented in our press release issued this morning that the North American architectural painting season got off to a slow start compared to last year. But it's important to keep this in perspective. It is traditionally the smallest revenue quarter of the year, and it is volatile year to year. So it's often not very representative of underlying demand trends. Robust feedback from our professional painting contractor customers has long been our most reliable indicator of North American architectural paint demand. These customers, almost universally, remain optimistic about 2019 and continue to report unseasonably high project backlogs in a very healthy pipeline of new projects. This consistent feedback underpins our confidence in our full-year outlook. in spite of the slow start to the season. Our sales results in the quarter highlighted the geographic variability in demand we have seen since mid-year last year. Volume growth in North America ranged from stable to strong with a few exceptions, while the softness in Asia and Europe was fairly broad-based, but also with a few noteworthy exceptions. Pricing was favorable across all of our businesses in a quarter. while the impact of currency translation on all three segments was a bit more of a headwind than expected. While we're not satisfied with our top-line performance, consolidated gross margin on an adjusted basis improved 60 basis points sequentially and was flat year-over-year at 43%. This is encouraging given our expectation that the rate of raw material inflation year-over-year will be highest in first quarter. We expect to see more gross margin improvement over the balance of the year as volumes pick up, the rate of raw material inflation moderates, and we continue to benefit from pricing actions announced over the past year. SG&A in the quarter came in largely as expected and will continue to maintain appropriate discipline on spending as the year unfolds. Within the Americas group, sales increased 3.6% against a prior year comparison of 6.6%. Sales volume growth in our North America stores fell short of our expectations. Sales to protective and marine and residential repaint contractors were our strongest customer segments in the quarter, both up high single digits over last year. All other customer segments were positive. Our business in Latin America went from positive double-digit growth last year to a high single-digit decline this year due to high teens' unfavorable currency translations. Segment profit dollars and margins for the group were negatively impacted by lower-than-anticipated volume, which in North America was likely the result of projects being postponed. During the quarter, we opened 15 net new stores, finishing the quarter with 4,711 stores in operation, compared to 4,624 last year. Our plan calls for this team to add approximately 90 new to 100 net new stores in the Americas by the end of this year. In the consumer segment, first quarter sales were positive in North America, even if we include the negative impact of the Guardsmen divestiture. Demand was considerably softer in non-domestic regions during the quarter, most notably Asia Pacific. We made pretty good progress on improving the profitability of this business. As segment margin excluding purchase accounting impacts, increased both sequentially and year-over-year. This is the highest quarterly operating margin reported by this segment since the acquisition of ALSPAR. We are successfully executing our strategy in this business, and we are well-positioned with our retail partners heading into this spring paint selling season. Performance coatings group sales in the quarter grew modestly against a challenging prior year comparison of 9.8% on a Performa basis. Revenue and volume growth in packaging and coil was offset by flat to down sales results in the segments other businesses. Geographically, sales increased in North America, but these gains were offset by declines in Asia Pacific and Europe, where sales were down high single and mid single digits respectively. We continue to see some benefit from our pricing actions across these businesses and regions as adjusted segment margin improved by 30 basis points year over year to 12.4%. EBITDA on the quarter was $533 million or $575 million on an adjusted basis to exclude the pension plan settlement expense and acquisition related costs. Working capital was a higher use of cash in the quarter as we built additional inventory through our fourth and first quarters to ensure our ability to respond to anticipated strong seasonal order volumes in our stores and retail customers. At the end of the quarter, we had $94 million of cash on hand that will be utilized to fund operations and reduce debt. The balance sheet reflects total debt of approximately $9.8 billion. We intend to reduce our net debt by approximately $600 million during the year, which will result in a net debt to EBITDA ratio below 3 to 1 by the end of 2019. After prioritizing debt reduction over other uses of cash during the past two years, we are resuming our historical capital allocation philosophy in 2019. We returned approximately $410 million to shareholders during the quarter. including $105 million in cash dividends and $305 million to purchase 750,000 shares of common stock. During the quarter, we increased our quarterly dividend by 31% to $1.13 per share. At quarter end, our share repurchase authorization stood at 9.38 million shares. Capital expenditures were 51 million in the quarter, depreciation was 65 million, and amortization was $79 million. As we move into the second quarter of 2019, we expect consolidated net sales to increase two to 5% compared to the second quarter of 2018, with the Americas Group at or above the high end of that range. As a reminder, second quarter revenue comparisons to 2018 in the Americas Group and the Performance Codings Group are the most challenging of the year. and Consumer Brands Group faces comparisons to early load-in volume from the Lowe's program and the divested Guardsman business. Our full year 2019 revenue guidance remains unchanged, with net sales increasing 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-related costs and non-operating items. On this basis, and given our sales outlook, we are confirming our 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. 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. A few additional data points for the full year may be helpful for modeling purposes. These data points have not changed from the guidance we provided in January. We expect raw material inflation for the full year 2019 will be in the low single digits compared to 2018. The rate of year-over-year inflation, assuming stable petrochemical feedstocks and no supply disruptions, should diminish from the level we saw in the first quarter as we progressed through the year. We expect incremental synergies of approximately $70 to $80 million in 2019 and a total annual run rate of approximately $415 million at year-end. We expect full-year capital expenditures to be approximately $320 million, depreciation to be about $257 million and amortization to be about $315 million. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions.