The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of third quarter 2021 results and our outlook for the fourth quarter of the full year of 2021. With us on today's call are John Marikis, Chairman, President, 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 issuer direct and via the Internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com beginning approximately two hours after this conference call concludes. 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'll open this session to questions. I'll now turn the call over to Jim Jay.

Thank you. Good morning, everyone. Sherwin-Williams remained focused in the third quarter on solving customer challenges combating rising costs with pricing, and investing for future growth in a difficult and highly fluid environment that is impacting the entire coatings industry. Demand remained generally robust, but raw material inflation remained persistently high and raw material availability failed to improve. While these conditions challenged our quarterly results, we continued to strengthen our customer relationships and take actions that strongly position us for the long term. We're confident in the demand outlook and even more confident in our strategy, our people, and our position in the market. Let me briefly summarize the quarterly numbers. All comparisons in our prepared commentary this morning are to the third quarter of 2020 unless otherwise specified. Starting with the top line, third quarter 2021 consolidated sales increased 0.5% to $5.15 billion. Raw material availability negatively impacted sales by an estimated high single-digit percentage, with about 75% of the impact in the Americas group. The remaining impact was largely in the consumer brands group, with an immaterial impact to performance codings group. Consolidated gross margin decreased 630 basis points to 41.6%, driven by lower sales volume, raw material cost inflation outpacing our price increases near term, and supply chain inefficiencies. SG&A expense decreased 2.7% in dollars and decreased 90 basis points to 26.6% as a percent of sales. Consolidated profit before tax decreased $264.1 million, or 30.2%, to $611.5 million. The third quarters of 2021 and 2020 included $70.3 million and $76.4 million of acquisition-related depreciation and amortization expense, respectively. Excluding these items, Consolidated profit before tax decreased 28.4% to $681.8 million. Diluted net income per share in the quarter decreased to $1.88 per share from $2.55 per share a year ago. The third quarters of 2021 and 2020 both included acquisition-related depreciation and amortization expense of 21 cents per share. Excluding these items, third quarter adjusted diluted earnings per share decreased 24.3% to $2.09 per share from $2.76 per share. EBITDA was $834.2 million in the quarter, or 16.2% of sales. Net operating cash grew to $2.1 billion, or 13.5% of sales, in the first nine months of 2021. Moving on to our operating segments. Despite strong demand, sales in the Americas group decreased 0.4%, as volume and mid-single-digit selling price increases could not fully offset the decrease related to raw material availability. Segment margin decreased 3.8 percentage points to 21.3%, resulting primarily from lower sales volume and higher raw material costs, partially offset by selling price increases. Segment SG&A remained basically flat year over year in dollars and as a percent of sales as we continued investing in strategic growth initiatives. Sales in the consumer brands group decreased 22.8% against a very strong comparison a year ago. The decrease included approximately 5 percentage points related to the wattle divestiture, lower volume, and the negative impact from raw material availability, partially offset by selling price increases. Adjusted segment margin decreased 11.7 percentage points to 14.7% of sales, resulting primarily from lower sales volume, higher raw material, and supply chain inefficiencies. partially offset by selling price increases and good sales and marketing cost control. Sales in the performance coatings group increased 17.4% driven by volume, price increases, and favorable currency exchange. Adjusted segment margin decreased 5.5 percentage points to 10.5% of sales as operating leverage from the higher volume selling price increases, and good cost control were more than offset by higher raw material costs, where inflation was the highest among the company's three operating segments. Let me now turn the call over to John Marikis for additional commentary on the third quarter and our year to date, along with our guidance for the fourth quarter and full year 2021. John?

Thank you, Jim, and good morning, everyone. Let me begin by reiterating the themes we provided on our September 29th update call. First, the demand environment remains robust across our pro-architectural and industrial end markets. Many external indicators, and more importantly our customers, remain highly positive. Demand is not the issue. Second, we are ready to meet this demand. We continue to invest in growth initiatives. We have significant production capacity available today, and we are bringing 50 million gallons of incremental architectural production capacity online over the next two quarters. Our capabilities are not the issue. The issues that impacted our third quarter and have persisted in October continue to be industry-wide raw material availability constraints and inflation. Let me be very clear on how we are responding. Nobody has more assets and capabilities than Sherwin-Williams. We're employing all of these to keep customers in paint and on the job better than our competitors. We will continue to focus on customer solutions. We are aggressively combating raw material inflation with significant pricing actions across each of our businesses. We implemented multiple price increases in the quarter. We will continue to do so as necessary. We continue to work closely with our suppliers on solutions to improve availability sooner rather than later. At the same time, we're exploring every avenue to better control our own destiny going forward, including our recent announcement to acquire Specialty Polymers Inc. There's no shortage of confidence on our team, which is deep and experienced. My deep thanks goes to all 61,000 members of our global family. We fully expect we will emerge from these current challenges a stronger company with stronger customer relationships and with continued strong value creation for our shareholders. In just a moment, I'll add some color to Jim's third quarter results summary. But first, I'd like to make a comment on our results year to date. While events largely outside of our control have forced us to adjust our expectations, we have still delivered a solid performance. 2021 year-to-date consolidated sales are up 9.4% or $1.31 billion. Despite high teens raw material inflation, adjusted PBT increased 1.5% or $33.1 million. And adjusted diluted net income per share increased 4.8% to $6.80 per share. Adjusted EBITDA is $2.73 billion, or 18% of consolidated sales. Even in this unusual environment, we've continued to make investments that will drive our momentum over the long term, and we are confident we will see significant margin expansion as availability and inflation headwinds eventually subside. Now, returning to segment performance in the third quarter. In the Americas group, raw material availability challenges were a significant drag on sales. The good news is that underlying demand remains sound, and reported backlogs are strong. We expect growth rates will improve significantly, commensurate with improvement in the industry supply chain. Sales growth in the third quarter was led by protective and marine, which was up by a high single-digit percentage. We're seeing good demand in this business, from customers in oil and gas flooring, and seal fabrication markets. TAG's largest business, residential repaint, grew by a low single-digit percentage against a strong double-digit comparison. As industry supply chain issues are resolved, we would expect this business to return to its prior growth levels, where we've delivered double-digit growth for the last five years. New residential sales increased by a low single-digit percentage New housing permits and starts have been trending very well since last summer, and our customers are reporting solid order rates. We're seeing a number of projects being pushed out as a variety of building materials beyond paint are in short supply. Property management was up slightly in the quarter. Improving apartment turns, along with a return to travel, the workplace, and school, are tailwinds that should support higher growth when raw material availability improves. Our commercial business was down slightly in the quarter. Similar to new residential, projects are taking longer to reach the painting phase due to short supply of multiple building materials. And finally, as expected, our DIY business was down double digits versus an extremely difficult comparison, which was exacerbated by the raw material availability issues. From a product perspective, interior paint sales performed better than exterior sales. with interior being the larger part of the mix. We realized a mid single digit increase in price in the third quarter resulting from our February one and August one price increases and our mid September surcharge. We would expect the combination of these pricing actions to result in a high single digit percentage price realization in the fourth quarter, putting our full year price realization for TAG in the mid single digit range. we will continue to evaluate additional pricing actions as needed. We've opened 50 net new stores year to date. Along with these new stores, we continue to make investments in sales reps, management trainees, innovative new products, e-commerce, and productivity-enhancing services. We are not taking our foot off the gas on these growth initiatives. Moving on to our consumer brands group. Sales decreased by a double-digit percentage driven by difficult comparisons to the prior year, consumers returning to the workplace, raw material availability issues, and the divestiture of the Waddle business. Overall, DIY demand continued to moderate to more normal levels compared to 2020. This was partially offset by growth in the North American Pros Who Paint category, which was up strong double digits in the quarter and year-to-date. While sales are down in all regions, sales were less impacted in North America, our largest region, compared to Europe and Asia, where COVID restrictions were more impactful. Pricing was positive in the quarter, though below the level of the Americas group. As you know, our global supply chain organization is managed within this segment. This team continues to work with suppliers to navigate the industry-wide raw material supply chain disruptions caused by winter storm Yuri and Hurricane Ida. We stand ready with ample capacity and are adding more to serve customers at a higher level as raw material availability improves. Last, let me comment on the third quarter trends in performance coatings group. We continue to see momentum as this is the fifth straight quarter of growth for this business. Group sales increased by more than 17% in the quarter, including a currency translation tailwind of 2%. Price was in the high single-digit range, and all regions and all divisions generated growth. Regionally, sales in the quarter grew fastest in Europe and Latin America, followed by North America and Asia. Every division in the group grew, the majority by double digits, driven by robust underlying demand, new customer wins, and share of wallet gains. I'll start with packaging, which generated strong double-digit growth against a high single-digit comparison last year. Sales were up double digits in every region. Demand for food and beverage cans remains robust, and our non-BPA coatings continue to gain traction within existing and new customers. Next is General Industrial, the largest division of the group, which posted its third consecutive quarter of strong double-digit growth. Sales were up double digits in every region. Sales were strong across most of our customer segments, led by heavy equipment, containers, and general finishing. Our coral coatings business remains a consistent performer. Sales grew by a double-digit percentage for the second consecutive quarter and were positive in all regions. This team continues to do an excellent job at winning new accounts in all regions. Construction and appliances led the growth. Automotive refinish sales increased by a mid-single-digit percentage. Miles driven are nearing pre-pandemic levels. New installations of our products and systems in North America remain strong. The industrial wood division generated low single-digit growth. Growth in North America, our largest region, was up strong double digits, but was offset by Asia Pacific, where COVID-related shutdowns had a significant negative impact on sales. New residential construction continues to drive robust demand for our products in kitchen cabinetry, flooring, and furniture applications. Before moving to our outlook, let me speak to capital allocation year to date. We've returned a little over $2.5 billion to our shareholders in the form of dividends and share buybacks. We've invested $2.1 billion to purchase 8.075 million shares. at an average price of $265.88. We distributed $442.9 million in dividends, an increase of 20.4%. We also invested $248 million in our business through capital expenditures, including approximately $36 million for our Building Our Future project. We ended the quarter with a net debt to adjusted EBITDA ratio of 2.5 times. We also announced the SICA and specialty polymer acquisitions, which are expected to close in early 2022, if not sooner. Turning to our outlook, we expect robust demand to continue in North American pro-architectural end markets. We expect DIY demand to continue normalizing as consumers return to the workplace. We expect industrial demand to remain strong. Raw material availability challenges will remain a headwind in the fourth quarter, but the situation is improving. We believe we have weathered the worst of Hurricane Ida, and supply should continue to come back online. We expect to be in a make-and-ship mode and do not anticipate building any inventory until the first quarter of 2022. On the cost side of the equation, our raw material inflation expectations for the year move up to the low 20% range, from the high teens given additional pressure we've seen since our last guidance. We do not see any meaningful improvement until well into 2022. All businesses remain aggressive in implementing price increases as necessary to offset these costs. We recognize that the timing of price realization will continue to put pressure on margins in the near term. And, as we've said many times, We expect margin expansion over the long term and maintain our gross margin target in the 45 to 48% range. Against this backdrop, we anticipate fourth quarter 2021 consolidated net sales will be up by a mid to high single digit percentage compared to the fourth quarter of 2020. We expect the Americas Group sales to be up by a mid to high single digit percentage with pro sales at or above the high end of this range and DIY sales returning to a more historic level. We expect consumer brand sales to be down by a mid-teens percentage, including a negative impact of approximately seven percentage points related to the wild divestiture. And we expect performance coating sales to be up by a mid-teens percentage. Embedded in our guidance is a similar impact to our architectural businesses. as a percent to sales from raw material availability as we experienced in the third quarter. For the full year 2021, we expect consolidated net sales to be up by a high single-digit percentage. We expect the Americas Group to be up by a high single-digit percentage, Consumer Brands Group to be down by a mid-teens percentage, including a negative impact of approximately four percentage points related to the WADL divestiture. and performance codings group to be up by a low 20s percentage. We expect diluted net income per share for 2021 to be in the range of $7.16 to $7.36 per share, compared to $7.36 per share earned in 2020. Full-year 2021 earnings per share guidance includes acquisition-related amortization expense of $0.85 per share and a loss on the wattle divestiture of 34 cents per share. On an adjusted basis, we expect full year 2021 earnings per share of $8.35 to $8.55. Let me close with some additional data points that may be helpful for your modeling purposes. We expect to see a slightly improved sequential gross margin in our fourth quarter as additional price increases are implemented in the quarter. We expect to see contraction in our fourth quarter operating margin due to the contraction in gross margin partially offset by leverage on SG&A due to the strong sales growth. We will continue making investments across the enterprise that will enhance our ability to provide differentiated solutions to our customers. We expect to have around 80 new store openings in U.S. and Canada in 2021. We'll also be focused on sales reps, capacity, and productivity improvements, as well as systems and product innovation. We also plan additional incremental investments in our digital platform and the Home Center channel. These investments are all embedded in our full-year guidance. We expect foreign currency exchange to be a tailwind of approximately 2% in the fourth quarter. We expect our 2021 effective tax rate to be slightly below 20%. We expect full-year depreciation to be approximately $270 million and amortization to be approximately $310 million. We expect full-year CapEx to be approximately $370 million, including about $70 million for our Building Our Future project. The interest expense guidance we provided last quarter remains unchanged at approximately $340 million. We expect to increase the annual dividend per share by 23.5% per share for the full year. We expect to continue making opportunistic share repurchases. We'll also continue to evaluate acquisitions that fit our strategy. We're on track to deliver solid full-year results, even with the considerable supply chain and inflationary headwinds we are experiencing. I remain extremely proud of our team. and their focus on providing solutions to our customers. Demand remains strong. Our customer relationships have strengthened, and we continue to invest in our capabilities. We expect to finish the year with significant momentum that will carry us forward in 2022. That concludes our prepared remarks. With that, I'd like to thank you for joining us this morning, and we'll be happy to take your questions.