The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of the second quarter of 2019 and the outlook for the third 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, and Jim Jay, Senior Vice President, Investor Relations and Communications. 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, August 9, 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 Jim Jay.

Thanks, Jessie, and good morning, everyone. Thank you for joining us on the call today. All comparisons in my remarks are to the second quarter of fiscal 2018, unless otherwise stated. Consolidated sales in the second quarter of 2019 increased $104.1 million, or 2.2%, to $4.88 billion. Currency translation rate changes decreased sales by 1.5%. Consolidated gross profit dollars in the quarter increased $142.8 million, or 7%, to $2.18 billion. Consolidated gross margin in the second quarter increased to 44.7% from 42.7% in the same period last year. Excluding impacts from purchase accounting, adjusted consolidated gross margin in the quarter increased to 44.9% from 43.1%. Selling, general, and administrative expense increased $23.4 million, or 1.8%, to $1.33 billion in the second quarter, but decreased slightly as a percent of sales to 27.3% from 27.4% in the same quarter last year. Interest expense for the quarter declined $4.3 million to $89.2 million. Consolidated profit before tax in the second quarter increased $137.6 million, or 25.6%, to $675.7 million. Our effective tax rate in the quarter was 30.3%, which includes the previously disclosed tax credit investment loss. Excluding acquisition-related costs and the tax credit investment loss, our effective tax rate on adjusted income for the quarter was 19.7%. Diluted net income per common share for the second quarter 2019 increased to $5.03 per share from $4.25 per share in the prior year's second quarter. Earnings per share in the second quarter of 2019 includes charges for acquisition-related costs and a tax credit investment loss of 75 cents and 79 cents per share, respectively. The $4.25 per share reported in the second quarter 2018 included charges for acquisition-related costs and environmental expense provisions of $1.23 and 25 cents per share, respectively. Excluding these items, adjusted diluted earnings per share increased by 14.7 percent to $6.57 in the second quarter 2019. from $5.73 last year. We have summarized the second quarter earnings per share comparison in a Regulation G reconciliation table in our press release. Let me now take a few moments to break down our performance by segment. Sales for the Americas Group in the second quarter increased $131 million, or 5%, to $2.76 billion. Comparable store sales in the U.S. and Canada increased 4.3% in the quarter. Regionally in the second quarter, our Southeast Division led all divisions, followed by Midwest, Eastern, Southwest, and Canada. Sales were positive in every division in the quarter. Second quarter segment profit increased $42.5 million, or 7.5%. to $612.4 million. Second quarter segment profit margin increased 50 basis points to 22.2% from 21.7% last year. Turning now to the consumer brands group. Second quarter sales increased $26.7 million or 3.4% to $804.5 million. Sales from continuing operations excluding approximately $16 million in revenue from the divested guardsman business increased 5.6% in the quarter. Second quarter segment profit increased $49.8 million or 54.7% to $140.7 million. Purchase accounting expense decreased segment profit by $22.5 million compared to $28.5 million in the second quarter 2018. Second quarter segment profit margin increased to 17.5% from 11.7% last year. Excluding the purchase accounting expense in both quarters, adjusted segment profit margin increased to 20.3% from 15.4% in the second quarter 2018. For our performance codings group, second quarter sales decreased $52.4 million, or 3.8%, to $1.32 billion. Currency translation rate changes reduced second quarter sales by 2.7%. Second quarter segment profit increased $6.1 million, or 4.3%, to $150.3 million, Purchase accounting expense decreased segment profit by $53.9 million compared to $47.6 million in the second quarter 2018. Second quarter performance coding group segment profit margin increased to 11.4% from 10.5% last year. Excluding the purchase accounting expense in both quarters, segment profit margin increased to 15.5% compared to 14% in the second quarter 2018. I'll conclude my remarks with an update on our California-led litigation. As we reported in a press release last week, 10 California cities and counties, Sherwin-Williams, and two other companies have mutually agreed to resolve litigation subject to court approval. The agreement ends a nearly 20-year legal battle that challenged the company's legal advertising of lead-based paints over a century ago when such paints were the gold standard and specified for use by the federal government, as well as state and local governments across the country. Terms of the agreement call for a total payment of $305 million, with each defendant paying approximately $101.7 million over six years. The $305 million is a significant reduction from the court's original 1.15 billion judgment and the reduced 409 million judgment ruling following the defendant's appeal. Sherwin-Williams continues to believe the California case was an aberration. All other appellate courts have found that companies should not be held retroactively liable for lawful conduct and truthful commercial speech decades after they took place. Seven other states have already rejected public nuisance claims similar to those brought in California. Sherwin-Williams is pleased to have reached an agreement to resolve this litigation, and it will continue to vigorously and aggressively defend against any similar current or future litigation. That concludes our review of our operating results for the second quarter. So let me turn the call over to John Marikas. who will make some general comments on the second quarter and provide our outlook for the third quarter and full fiscal year 2019. John?

Thank you, Jim, and good morning, everyone. Thanks for joining us. I'd like to make just a few additional comments on our second quarter before moving on to our outlook. Our second quarter was a strong one with record results in net sales, EBITDA, profit before taxes, and net operating cash. While consolidated second quarter sales came in at the low end of our expectations, North American paint stores, the growth engine of our company, performed well in the quarter and was above the high end of our revenue guidance as we anticipated. Overall, our consolidated sales results continue to highlight significant regional and end market demand variability, with growth in North America and Latin America partially offset by softness in Asia and, to a lesser degree, Europe. Pricing was favorable across all of our businesses in the quarter. Consolidated gross margin on an adjusted basis improved sequentially and year-over-year to 44.9%, just below the low end of our annual long-term target. The improvement was driven by the realization of previously announced pricing actions and a sequentially lower rate of raw material inflation. SG&A in the quarter came in largely as expected, and will continue to maintain appropriate discipline on spending as the year unfolds. All three segments delivered sequential and year-over-year profit margin improvement. Within the Americas group, sales increased 5% against a prior year comparison of 7.7%. Sales were positive in all North American customer end markets in a quarter, led by residential repaint, which was up high single digits. Sales in protective and marine, New commercial and property management were all up mid-single digits, and new residential sales were also positive. Selling conditions remained challenging throughout much of the quarter, likely delaying a number of projects in multiple end markets. Our customers continue to report very solid backlogs heading into the back half of the year. Looking at total segment profitability, segment profit dollars increased by more than $42 million. Segment margin expanded by 50 basis points to 22.2%, and incremental margin was nearly 33%. Year to date, we've opened 20 net new stores, finishing the quarter with 4,716 stores in operation, compared to 4,642 last year. Our plan calls for this team to add approximately 80 to 100 new stores in North America by the end of this year. In the consumer segment, second quarter sales increased by 3.4%, including the impact of the Guardsmen divestiture, which was about 2.1%. Sales and profitability improved in North America and Europe, but were partially offset by softer demand in Asia and Australia and New Zealand. Volume leverage and cost control, which were partially offset by incremental investments in a new customer program, are enabling us to continue to drive the profitability of this business. as segment margin, excluding purchase accounting expense, increased both sequentially and year over year to 20.3%. We continue to feel very good about our strategy in this business, and in particular, our relationship with our largest customers. Performance Codings Group sales were down 3.8% in the quarter, with variability by region and business. Comparing businesses, revenue growth in our packaging and coil divisions was more than offset by softness in the segments other businesses, most notably in our industrial wood division, which continues to be impacted by tariffs. Geographically, sales were up in Latin America and flat in North America, which were more than offset by softness in Asia and Europe, where sales decreased by low double-digit and mid-single-digit percentages, respectively. Notably, packaging and coil continued to be positive outliers in Asia and Europe. Despite the sales decline, adjusted segment margin increased 150 basis points to 15.5%, evidence of good cost control and that recent pricing actions are gaining traction to offset the raw material inflation we've experienced over the last two years. EBITDA on the quarter was $908 million, or $921 million adjusted to exclude integration costs. Adjusted EBITDA margin was 18.9% in the quarter. Adjusted EBITDA year to date was $1.5 billion, or 16.8% of sales. Year to date, we've returned approximately $660 million to shareholders through cash dividends and share repurchases, an increase of 33% year over year. At the end of the quarter, we had approximately $9.5 billion of debt on the balance sheet. We reduced debt by approximately $375 million in the quarter and intend to retire a total of approximately $600 million this year, which will result in a net debt to EBITDA ratio below 3 to 1 by the end of 2019. We paid $105 million in cash dividends and purchased 325,000 shares of common stock for $145 million in the second quarter. At quarter end, our share repurchase authorization stood at 9.05 million shares. Capital expenditures were 77 million in the quarter, depreciation was 65 million, and amortization was 78 million. As we move into the third quarter of 2019, we expect consolidated net sales to increase by a low single-digit percentage compared to the third quarter of 2018. Although we do not typically provide quarterly sales guidance by segment, I'd like to provide some additional color this quarter due to end market variability. We expect growth in the Americas Group to be in the mid single-digit range. I want to reiterate that we continue to feel very good about the demand environment for our North American stores, with our customers reporting full order books and working to catch up on jobs that were likely delayed by weather in the second quarter. For the consumer brands group in the third quarter, we expect sales to be down by high single digits as we face tough comparisons to the largest portion of last year's load-in volume for the Lowe's program, as well as the final quarter of the divested guardsman business. We anticipate performance coding sales to be up by a low single-digit percentage. While comparisons do ease in the back half of the year, we do not see a near-term catalyst driving significant improvement in the European and or Chinese macroeconomic environment at this time. We expect demand in these regions to remain highly variable as it has over the first half of the year compared to a relatively more stable demand environment in North America. As a result of our revenue outlook for the third quarter, we are reducing our full year 2019 revenue guidance and now expect sales to increase two to 4% compared to the full year 2018. At the same time, we feel good about North American stores volume in the second half, the progress of our pricing initiatives, the trajectory of raw material inflation, and our ability to control spending. Given these dynamics, we are reaffirming our adjusted 2019 full-year diluted net income per common share guidance to be in the range of $20.40 to $21.40 per share, which excludes Valspar acquisition-related costs and non-operating items. This is an increase of approximately 13 percent 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 reconcile adjusted and gap earnings per share. 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 updated in April. We expect raw material inflation for full year 2019 will be in the low single digits compared to 2018. The rate of our year-over-year inflation, assuming stable petrochemical feedstocks and no supply disruptions, should diminish from the level we saw in the second quarter as we progress through the year. 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 our 2019 effective tax rate to be approximately 20 percent. 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.