The Sherwin-Williams Company

Good morning. Thank you for joining the Sherwin-Williams Company's review of second quarter 2022 results in our outlook for the third quarter and full year of 2022. With us on today's call are John Morakish, Chairman and CEO, Al Misteson, 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 or direct 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 will open up this session to questions. I will now turn the call over to Jim Jay.

Thank you, and good morning to everyone. Our second quarter results came in below our expectations and conclude what we knew would be a challenging first half to the year. On the top line, the quarter was characterized by strong demand in pro-architectural and North American industrial end markets, partially offset by softness in the North American DIY channel. which we first described at our investor day on June 8th, and tight supply of certain resins, particularly alkyd resins, which impacted our North American non-paint sales, namely aerosols and stains. Internationally, demand deteriorated faster than anticipated in Europe, and we saw no real recovery in China following the lifting of COVID lockdowns, both of which meaningfully impacted consumer brands, and performance coatings group sales. Our earnings per share were impacted by multiple factors, including no meaningful improvement in raw material costs, supply chain inefficiencies incurred in serving our customers, the sales shortfall in North American DIY, slowing European and Asian demand, and higher other and interest expense. I'll go through just a few of the numbers at a high level and then turn it over to John who will talk about the demand and cost trends we are seeing, how we're responding, and our revised outlook for the year, including what we expect will be significant earnings per share growth in the second half. Comparisons in my comments are to the prior year period, unless stated otherwise. Starting with the top line, second quarter 2022 consolidated sales increased 9.2%, slightly below the low end of our guidance and driven by the shortfall in consumer brands grew. Pricing was in the low double-digit range. Consolidated gross margin decreased to 41.7%, driven by cost inflation. On a sequential basis, gross margin improved by 60 basis points, reflecting our pricing actions. SG&A expense decreased to 25.9% of sales. Consolidated profit before tax decreased 9.7 percent to $739.9 million. Diluted net income per share in the quarter was $2.21 per share versus $2.42 per share a year ago. Excluding Valspar acquisition-related amortization expense, second quarter adjusted diluted net income per share was $2.41 per share versus $2.65 a share a year ago. EBITDA in the quarter was $976.1 million, or 16.6% of sales. Moving on to our operating segments. Sales in the Americas group increased 8.1% against a 22.6% comparison High single-digit pricing and higher professional architectural sales volume was partially offset by lower volume in protective and marine and DIY. Segment margin decreased to 21%, resulting primarily from lower sales volume and higher raw material costs, partially offset by selling price increases and good cost control. Sales in the consumer brands group increased 0.9 percent, inclusive of a high single-digit price increase. Demand was soft in all regions, particularly outside of North America, and tightness in alkyd resins impacted North America non-paint sales. Adjusted segment margin decreased to 11.2 percent of sales, resulting primarily from lower sales volume, higher raw material costs, and supply chain inefficiencies. partially offset by selling price increases. Sales in the performance codings group increased 15.2 percent against a 41.3 percent comparison and were driven by double-digit price increases and low single-digit sales from acquisitions, partially offset by a low single-digit FX impact. Adjusted segment margin increased 80 basis points to 13.8 percent of sales, due primarily to higher selling price increases and good cost control. Additionally, I'll point out the admin segment this quarter, where we had a headwind of $45.1 million year over year, or about 13 cents per share. This was driven primarily by investment losses and gains, higher interest expense, a gain on disposition of assets last year, and higher SG&A expenses. partially offset by lower compensation expense. Let me now turn the call over to John for additional commentary on the second quarter, along with our outlook for the third quarter and full year 2022. John?

Thank you, Jim, and good morning, everyone. Let me be clear that we are not satisfied with our results in the quarter. Our job is not to just report results, but to influence results. We fell short of our expectations this quarter as we continue to operate in a highly inflationary cost environment coupled with ongoing regional challenges impacting demand. Saying that, we continue to see positive trends in much of the business, and we expect to deliver a strong second half of the year. We have confidence in our strategy. We have confidence in our business model. And we have incredible confidence in our people. Let me start by describing how the quarter played out following our June 8th Investor Day event. Pro-architectural demand remains strong. Encouragingly, sales have been particularly strong month to date in July, and contractors are reporting strong backlogs, which bodes very well for our second half. The lower demand for DIY that we described continued, and tight alkyd resin supply negatively impacted North America non-paint categories. Europe significantly softened further, and there was no meaningful recovery in China post the lifting of the COVID lockdown. This impacted consumer brands and portions of performance coatings. There was no improvement in raw material costs. While some key feedstocks have come down sequentially, the issue is timing, as resins, solvents, and other key inputs are taking longer to reflect this trend than anticipated. Additionally, the rest of the cost basket remained highly elevated, including labor, transportation, fuel, and other costs. While the supply chain for raw materials continued to improve, it remained tight and subject to shocks. Notably, certain specialty resins crucial to several of our industrial coatings products were in short supply. With the tightness in the supply chain, we continue to have inefficiencies in our operations, but have chosen to continue serving our customers, albeit at higher costs. While the cost and regional pressures we are seeing are real, there is no sense of panic amongst our team, which is deep and experienced. We continue to operate with urgency and great determination, and we're taking the following actions. We've announced and are implementing a 10 percent price increase in the Americas Group effective September 6th. Significant pricing actions are also being taken in our other two groups. We remain highly focused on capturing demand and gaining share. We're managing our expenses tightly across all our businesses. These are focused on general and administrative spending rather than growth. Before moving on to our outlook, let me provide some additional color on our second quarter. In the Americas group, sales growth was strong and volumes were positive in pro-architectural market segments. Excluding DIY and protective and marine, sales were up 8.7% in North America paint stores. Against very difficult comparisons and as we expected, sales gains for the group were driven by price as total volume was down slightly. The sales growth was led by property management and new residential, both of which increased by a double digit percentage. Residential repaint was up high single digits and commercial was up by a mid single digit percentage. DIY was down low single digits. Limited availability of certain resins impacted us in protective and marine, which was up by a mid single digit percentage. We've also begun to see margin recovery in the business as segment margin expanded sequentially. From a product perspective, exterior paint sales grew faster than interior sales, with interior being the larger part of the mix. We opened 19 net new stores over the first half of the year and still plan 80 to 100 for the year. We also added sales reps and territories in the quarter, along with ongoing growth investments in management trainees, innovative new products, e-commerce, and productivity-enhancing services. Our consumer brands group had a very difficult quarter. Sales in North America were up by a high single-digit percentage, but well below our expectations, given a favorable comparison. The slowing demand we cited at our investor day did not improve over the remainder of the month. and we experienced tight supply in certain resins, particularly alkyd resins, that significantly impacted our North American non-paint sales. On a positive note, the pros who paint segment, while small, again grew by a strong double-digit percentage. Sales in China were down by a very high double-digit percentage due to COVID-related lockdowns in a challenging comparison. Europe was also down high double digits due to the slowing macroeconomic environment in a challenging comparison. Pricing was positive in the quarter and in the high single-digit range. Segment margin decreased significantly due to lower sales volume, increased raw material costs, and supply chain inefficiencies. In contrast, our performance codings group had a very nice quarter. Sales were up mid-teens, including mid-teens pricing. Low single-digit sales from acquisitions were more than offset by FX headwinds. Adjusted segment margin improved 80 basis points year over year and 200 basis points sequentially, indicative of executed pricing actions. Regionally, sales increased strong double digits in North America and Latin America against difficult comparisons. Sales in Europe were up low single digits. Sales were backward, in Asia, largely related to COVID lockdowns. Nearly every division in the group grew, led by coil and packaging, both of which were up strong double digits against double digit comparisons. We are clearly gaining share in these businesses. Sales in general industrial and auto refinish increased high single digits against very strong double digit comparisons. Industrial wood sales decreased low single digits, mainly related to Asia and COVID lockdowns and a slowdown in Europe. Before moving to our outlook, let me speak to capital allocation in the quarter. We returned approximately $453 million to our shareholders in a quarter in the form of dividends and share buybacks. We invested $296 million to purchase 1.1 million shares at an average price of $269.46. We distributed $156.2 million in dividends. We also invested $129 million in our business through capital expenditures, including $89 million in core capex and $40 million for building our future projects. Additionally, the acquisition of Gross & Forthune and Duraflex closed on July 1st. We ended the quarter with a net debt-to-EBITDA ratio of 3.4 times, as we increase short-term borrowings to fund our recent acquisitions. We expect to end the year around three times, and we'll drive the ratio to our long-term target of 2 to 2.5 times range in 2023. We will use cash in the second half of 2022 to manage debt, and share buybacks will be done to offset option dilution. Turning to our outlook, as we've communicated multiple times going back to January of this year, We expected 2022 would be a year of two contrasting halves with difficult first half comparisons easing in the back half. We expect to deliver a strong second half with sales up low double digits to mid-teens percentage and diluted earnings per share up by 35 percent at the midpoint of our guidance. Within the Americas Group, we continue to see extremely strong demand across all of our pro-architectural markets. including new residential despite higher interest rates, with customers reporting strong backlogs that will take them through the end of the year and likely longer. We also see a unique opportunity to win new business as competitors transition their pro-contractor business models. Within the consumer brands group, we expect more modest growth as the North American DIY consumer faces inflationary pressures and Europe and China remain challenging. Within performance codings group, demand remains strongest in North America, our largest region. European demand has slowed in the second quarter, and we do not expect meaningful improvement in the second half of the year. In Asia, the pace of recovery from prior COVID lockdowns in China and prospects for additional lockdowns make it difficult to assess demand trajectories. From an industry supply chain perspective, we're getting the raw materials we need, with some exceptions, such as alkyd resins, which remain choppy. At the same time, it's not optimal. In our own operations, we expect inefficiencies to continue near term, as we've decided to take the necessary steps required to overcome these challenges and ensure that we are serving our customers with product where and when they need it. Exiting this era with our customers will prove beneficial to our shareholders. On the cost side of the equation, we're raising our mid-teens raw material inflation guidance to high teens, as expected cost moderation did not materialize in the second quarter and appears to be pushed out a quarter or two. To be clear, while the timing is not precise, we do expect raw material costs to moderate. we do expect to hold onto our pricing based on the value we deliver and the customer-facing investments we've continued to make. And we do expect margins to expand. There's considerable short-term volatility in the market, and our visibility beyond a quarter or two is limited. Our pricing actions remain on track. Additionally, the highest rate of inflation we've seen in 40 years is affecting the other elements of our cost basket, including labor, transportation, fuel, and other costs. We're combating these increases with additional selling price increases in all three segments in our second half of the year. So, specifically for the third quarter of 2022, we anticipate our consolidated net sales will increase by a low to mid-teens percentage, inclusive of a low double-digit price increase. We expect the Americas Group to be up by a high teens percentage. We expect consumer brands to be up by a low single-digit percentage. And we expect performance coatings to be up by a high single to low double-digit percentage. For the full year 2022, we are maintaining our consolidated net sales guidance based on the momentum we're seeing in pro-architectural and North American industrial. We continue to expect consolidated net sales to increase by a high single-digit to low double-digit percentage. We expect the Americas Group to be up by a low double-digit to mid-teens percentage. We expect Consumer Brands Group to be down by a low single-digit percentage, and Performance Codings Group to be up by a low double-digit to mid-teens percentage. we are decreasing our earnings guidance for the full year based primarily on the headwinds we described previously. The incremental pricing actions and general and administrative cost reductions I described earlier will not fully offset these headwinds immediately. We now expect diluted net income per share for 2022 to be in the range of $7.65 to $7.95 per share compared to $6.98 per share earned in 2021. Full year 2022 earnings per share guidance includes Valspar acquisition related amortization expense of approximately 85 cents per share. On an adjusted basis, we expect full year 2022 earnings per share of $8.50 to $8.80, an increase of 6.1% at the midpoint over the $8.15 we delivered in 2021. This implies a second-half adjusted diluted net income per share of $4.63 per share at the midpoint, an increase of 35 percent over the same time last year. In addition, we provided updated guidance on several of our full-year data points in our slide deck, including our expectations for FX, CapEx, interest expense, depreciation, and amortization. We expect our full-year tax rate will remain in the low 20 percent range. While we continue to operate in an uncertain macroeconomic environment, we remain confident in our strategy. We expect to deliver a strong second half of the year and, more importantly, create shareholder value over the long term through the following actions. We will continue leveraging strong pro-architectural volume demand in North America paint stores while investing in future growth with incremental new stores and sales reps. We will continue implementing appropriate pricing actions across the company to offset persistently higher input costs, with a focus on regaining our gross margins back to our long-term target range of 45% to 48%. We will continue to invest in the Pros Who Paint initiative in Consumer Brands Group, and in products and services that customers value in the performance codings group. We will continue investing in acquisitions that accelerate our long-term strategic plan, add top-line growth, and expand our operating margins, as we've demonstrated recently through the specialty polymers, SICA, gross and profune, and Duraflex acquisitions. We will continue appropriately managing our general and administrative costs while investing in future growth initiatives. We will continue to review our portfolio of businesses, brands, and customer programs to ensure they're adding above-market growth and long-term shareholder value. We will maintain our disciplined capital allocation philosophy. We will not hold cash while investing appropriately in CapEx, paying a dividend, targeting acquisitions that accelerate our strategy, and absent M&A, buying back our stock. Our leadership team is experienced. Our 61,000 employees are focused on the task at hand, and we expect to win. That concludes our prepared remarks. We'll be happy to take your questions at this time.