The Valspar's CEO Discusses F1Q 2014 Results - Earnings Call Transcript

Feb.12.14 | About: The Valspar (VAL)

The Valspar Corporation (NYSE:VAL)

F1Q 2014 Results Earnings Conference Call

February 12, 2014 11:00 a.m. ET

Executives

Tyler Treat - Treasurer and Vice President of Investor Relations

Gary Hendrickson - Board Chairman and Chief Executive Officer

James Muehlbauer - Executive Vice President, Chief Financial and Administrative Officer

Analysts

Ghansham Panjabi - Robert W. Baird

Ivan Marcuse - KeyBanc Capital Markets

Robert Koort - Goldman Sachs

Duffy Fischer - Barclays Capital

Dmitry Silversteyn - Longbow Research

Don Carson - Susquehanna

PJ Juvekar - Citi

Ernie Ortiz - Credit Suisse

David Begleiter - Deutsche Bank

Jeffrey Zekauskas - J. P. Morgan

Charles Dan - Morgan Stanley

Steven Schwartz - First Analysis

Rosemarie Morbelli - Gabelli & Co.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Valspar Fiscal 2014 First Quarter Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to our host, Tyler Treat, Treasurer and Vice President of Investor Relations. Please go ahead.

Tyler Treat

Good morning and welcome to our Fiscal 2014 first quarter earnings call. We have two speakers today who will provide insight on our business and the first quarter results we announced this morning. Gary Hendrickson, our Chairman and Chief Executive Officer, and Jim Muehlbauer, Valspar's Executive Vice President, Chief Financial and Administrative Officer. As always, after our prepared remarks, we'll be happy to take your questions.

Let me also remind you that comments made by me or by others representing Valspar may contain forward-looking statements which are subject to risk and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. These filings can be found in the Investor Relations section of our corporate website at valsparglobal.com.

And, finally, please note that our reported results this morning include non-GAAP financial measures. These results should not be confused with the GAAP numbers in today's earnings release or with the GAAP numbers we will report on our Form 10-Q. For GAAP to non-GAAP reconciliations of the reported to adjusted results and guidance, please refer to the supplemental schedules in this morning's news volume.

With that, I'll turn the call over to Gary Hendrickson.

Gary Hendrickson

Thank you, Tyler, and good morning everyone. We are pleased with our overall performance in the first quarter with total sales growth of 9% and a 17% increase in EPS. These results build on the momentum from last quarter and are consistent with our growth agenda for fiscal 2014. Our plans for this year assumed improved stability in some of our key end markets, continued growth for new business, benefit from the Inver acquisition, and efficiencies from productivity initiatives.

Early into the year, we are tracking well against each of these drivers and I will talk about several highlights from each of our reporting segments. In our paint segment, we continue to see the benefits from an improving U.S. housing market. First quarter sales increased double digits in our U.S. consumer paint business, driven by growth in both the home improvement and independent hardware store channel. Part of this growth is our Professional Paint program at Lowe's. This program significantly enhances our ability to serve the large, professional paint market. We remain very positive on this programs and its growth potential.

Another part of our growth is Ace Hardware. We have been manufacturing all of their private label paints for the past year and in Q4 of last year we also began shipping Valspar branded paints to Ace. The combination of private label and branded paint sales to Ace in the first quarter is one of the key drivers of our total growth in the paint segment. We continue to expect to have over 3000 stores redesigned and reset before the summer painting season.

Our international paint businesses also had a good first quarter. We saw continuing progress in Australia, where the housing market has shown some stability with an increase in new housing approvals, and we have gained market share in both the trade and resale channel. Our first quarter paint sales in Australia were up by mid-single digits in local currency, which is a significant improvement over the declines experience last year. Additionally, we had a good quarter in consumer paint in China. We continued to expand the product range and distribution of our products serving the large, affordable housing market and benefitted from a relatively easy comparison due to the softness experienced in the first quarter last year.

Moving now to our coatings segment. A number of our key product lines marked volume and share gains in the quarter through new business wins. Let me highlight a few. We continued to benefit from new business growth and increased volume in our packaging product line, where we secured new volume with key customers in both the U.S. and Europe. Our wood product line also continues to perform well, benefitting from new business in addition to the U.S. housing market improvement. The general industrial markets that we serve remain soft. However, we saw sequential improvement in our general industrial product lines sales with particular strength in the China off-road and construction equipment market. We are encouraged by this performance but continue to expect these end markets to remain uneven as we move through the year.

The other large growth driver in the quarter was the acquisition of Inver, which continues to progress nicely. Inver strengthens our presence in Europe and provides a proven distribution model that we can leverage in this important market. We are pleased by Inver's performance and our integration activities remain on plan.

And finally, our restructuring and productivity initiatives are generating the efficiency in savings we planned for in our global operations. In summary, we are off to a good start but it's early in the year. We continue to expect annual EPS in the range of $3.95 to $4.15.

And with that, I will turn it over to Jim who will provide some additional context on the quarter.

James Muehlbauer

Thank you, Gary, and good morning everyone. I would like to provide you with an overview of the key drivers behind our performance in the first quarter and some context on our expectations for the year.

Overall sales growth quarter of 9% was led by volume gains in both our coatings and paint segment driven by acquisitions and new business wins. Looking specifically at the paint segment. Sales increased 10%. We saw double-digit sales growth in North America consumer paints. This growth included benefits from the rollout of Valspar branded products at Ace, and growth from our expanded Professional Paint program with Lowe's.

We also saw growth in our international markets. Improvements in China were driven by the expanded distribution of products targeted at the affordable housing sector, which continues to represent a large opportunity for us in this market. Paint sales in China in the quarter also benefited from a weak comparison period in the first quarter of last year and sales decline. In Australia, we saw sales increase in mid-single digits in local currency, demonstrating further progress in this market. Our team in Australia has worked to position the business for long-term improvement and the benefit of that work is now becoming more visible in our results, with share gains in both the retail and trade.

Before I move on to discuss sales in the coatings segment, I wanted to remind you that we will anniversary both the acquisition of the Ace private label business, and the launch of the expanded Lowe's Pro program starting in the second quarter of this year. Now that these items will be included in our base, the sales growth rates in paint will be lower in the balance of the year. This is consistent with our plan.

In the coatings segment sales also increased 10%, driven primarily by the Inver acquisition. We saw another quarter of high single-digit volume growth in our packaging product line from new business wins in the U.S. and Europe. Our wood business also had another good quarter, benefiting from the combination of new business wins and continuing improvements in the housing market. Sales in the general industrial product line are still challenged and were down mid-single digits in the first quarter, excluding acquisitions. We did see some sequential improvement from Q4 of last year, in part driven by new business wins and increase customer build in the off-road market in China. As you recall, last year several of the general industrial product lines experienced end market weakness and in some cases large customer inventory reduction. It's good to see some sequential improvement in the first quarter but it's early in the year. We continue to expect uneven demand in these end markets.

Let's move to discuss several other financial highlights. The first quarter gross margin rate of 34% increased approximately 40 basis points over last year. This increase was driven by improved sales mix, better price cost in China, and benefit from leveraging higher overall sales volumes. SG&A expense in the quarter was 22.8% of sales, reflecting approximately 15 basis points improvement over the prior year. The rate improvement reflects the leverage benefit of higher sales. SG&A spending increased 8.5% in the first quarter, reflecting the addition of Inver, investments related to growth initiatives, and slightly higher FX.

Bringing it all together, total operating income increased 15% and operating margins expanded 50 basis points to 11.2%. From a segment perspective, EBIT margins in paints increased 250 basis points to 9.4%. This growth was primarily the result of benefits from much higher sales volumes and improved profitability in China and Australia. In addition, we are also comparing against a soft Q1 last year, when segment EBIT margins declined 120 basis points. Looking forward, we do not expect paint segment sales to grow at the rate experienced in the first quarter, given the annualization of the new business wins I discussed earlier. In addition, as we move into the painting season, we will increase spending to support key growth initiatives and retail programs. As a result, we do not expect the same level of year-over-year expansion in our paint segment EBIT margins as experienced in the first quarter.

In the coatings segment, EBIT dollars were up 6% over the previous year and margins declined 60 basis points to 14.3%. The decline in rate continues to be primarily the result of the Inver acquisition. Wrapping up the highlights from the quarter, we continue to focus on improving shareholder returns and repurchased approximately 975,000 shares of the company stock for a total investment of approximately $69 million.

In closing, our fiscal 2014 plans called for improved sales and operating performance driven by the benefits of the Inver acquisition, new business initiatives and improved stability in customer demand in several of our key end markets and geographies. As we enter the second quarter, our overall outlook and guidance for the year remains unchanged.

With that, we would like to thank you for your interest in Valspar and open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) First we will go to the line of Ghansham Panjabi with Baird. Please go ahead.

Ghansham Panjabi - Robert W. Baird

Since you don’t provide quarterly guidance, can you just give us a view as to whether 1Q was better than your own internal expectations, and if it was better, what are one of the two drivers that drove the upside in your view?

James Muehlbauer

Yes. Essentially Q1 came in very close to what we anticipated. Certainly as we go through the balance of the year, we will focus on delivering our annual results. But sales and margins in each of the segments were very consistent with what we anticipated in the first quarter.

Ghansham Panjabi - Robert W. Baird

Okay. That’s great context. Thank you. And then can you just take us through, region by region across your paint business. You seem to be recovering in Australia and China but can you just broadly tough on the momentum you are seeing in those markets. And on the U.S. on an organic basis, what do you estimate the market grew excluding some of the growth initiative impacts. Thanks.

Gary Hendrickson

Yes, Ghansham, it's Gary. Second part of your question first, I don’t know what the market growth was. I would guess, probably low single-digits, something like that in our quarter. But we don’t get that data until a couple of months, two or three months from now. But our business was driven mainly by new business wins in the quarter. And kind of reiterating some of the points that Jim and I made in our opening comments. I mean we had a good quarter in every region of the world this quarter. Top line growth at 10% was in line with our expectations. We expected the business in China to recover in the quarter. We knew that our Australia business was getting better.

Margin expansion, as Jim explained, was also expected. We said in our opening remarks, we had a soft Q1 last year. Particularly in China because of the way our distributors ordering patterns looked in fiscal '12. So about half of that improvement in margin was expected and I would call that more or less a return to normal. The rest of it was a combination of mix improvement, leverage on higher volumes, Australia performed better and we see raw material cost in China lower today than they were last year because the market generally is weak, the overall market. So our international business is, again, Australia had positive volume and positive sales in local currency.

We are seeing some signs of stability in the housing market. I would say the team there thinks it has stabilized. You know housing approvals were up pretty substantially. Next six months or so after that we start to see the builds occur. But just as importantly for us, we are seeing now the benefits of the restructuring activities that we have been engaged in over the last couple of years and the commercial initiatives. You know we are confident that for the second quarter in a row, we took share in both the retail channel and in the trade channel.

China was good. As Jim said, we continue to expand the product line and distribution of our affordable housing products, that was a good benefit in the quarter. We got leverage on volume and as I said, raw material costs were under control. And in U.S. we had a good quarter as well, particularly with the increased volumes that we are experiencing due to the roll out of Valspar products at Ace. As I mentioned in my opening remarks that Ace program was going really well. We have something like 1500 stores redesigned and reset at this point in time, and we are on track to have over 3000 Ace stores set with the Valspar program before the summer painting season. So I would call it a quarter where all of our paint businesses regionally were firing on most cylinders.

Operator

Next we will go the line of Ivan Marcuse with KeyBanc Capital Markets.

Ivan Marcuse - KeyBanc Capital Markets

A couple of questions and just a quick follow-up to Ace. So Ace, that you are in 1500 stores, is that 1500 stores that you have the Valspar product in and you expect to be in 3000 or is that just the redesign or your marketing initiative is in all 1500 stores? Just to clarify.

Gary Hendrickson

1500 stores are reset with the new Valspar racks, painting [ph] machines etcetera, and there is Valspar paint in the store. So there will be 3000 stores plus, by the start of the painting season they will have Valspar paint on their shelves, Ivan.

Ivan Marcuse - KeyBanc Capital Markets

Great. And then if you look at the consumer business, how much did new business ex Ace, contribute to the results on the top line?

James Muehlbauer

Yes. So we are still anniversaring the rollout of Lowe's Pro from last spring. This is the last quarter where we are going to see the benefits of having that in the portfolio. We will start to lap that in earnest in Q2. So that was the other big part in addition to Ace. Really the two drivers from a new business standpoint in the quarter in the U.S. consumer business were the Valspar branded products at Ace and Lowe's Pro. So we saw core growth in the core business with our private label paint at Ace and with Lowe's, but the big drivers were just the initial volumes from Lowe's Pro and Valspar branded products.

Gary Hendrickson

And I would like to add to that, Jim, for the international businesses, Ivan, we went from negative volumes in sales in Q4 last year in Australia, slightly negative, very slightly negative, to positive mid-single digits and that’s a reasonably sizable business. And our China business had a very quarter. So international businesses contributed significantly to the results in the quarter, both top and bottom line.

Ivan Marcuse - KeyBanc Capital Markets

Is profitability in Australia near double-digits?

Gary Hendrickson

Let's just say, it's much improved over the next year, we are not at our target yet.

Ivan Marcuse - KeyBanc Capital Markets

Great. And then you have mentioned raw materials being favorable, how much did that help the quarter? Were raw materials cost down or up or...?

Gary Hendrickson

It was really only in China. I said it was China only. Our overall raw material basket through the company was more or less flat.

Ivan Marcuse - KeyBanc Capital Markets

Great. And then my last question and I will get back in. Speaking of new business, the container opportunity that you announced, I believe in late November, early December. How do you see that opportunity unfolding for you and where do you think the potential is for container growth like you have the next year or two?

Gary Hendrickson

Sure. Well, first of all the container market is still worse than anemic. You pick a word worse than anemic and that’s what the container looks. So there aren't many containers being built today. But our partnership is with Maersk, which is the largest shipping company in the world. Maersk makes some of their own containers and then they buy containers from other shipping companies. They are building a factory in South China. We are participating in that as a partner and will be the exclusive supplier to that Maersk factory. When that factory is up and running, sales to that factory will be in excess of $20 million a year. But more importantly, Ivan, what we are trying to do is we are trying to change the shipping container industry in terms of switching from highly polluting, expensive, dangerous solvent based products to our water-based product. Maersk is a leader in the shipping industry and a leader in the container industry and a reference customer. We think that this is an enabler of our strategy to convert that market.

Ivan Marcuse - KeyBanc Capital Markets

Great. In terms of sales where do you think right now -- I know, right now it's terrible, but if you look out three, four, five years, where do you think the ultimate potential of that market is?

Gary Hendrickson

So it swings wildly. I mean, there was -- a few years ago, we think there was almost $1 billion worth of container coatings sold. Last year, we think there was around $100 million or $150 million sold. So we went into the container business with our eyes wide open. We know now that it's a very cyclical market and so I know that makes it difficult for planning and your modeling but it's no less difficult than it is for us.

Operator

Next we will go the line of Robert Koort with Goldman Sachs.

Robert Koort - Goldman Sachs

Gary, just curious, you know that there had been some rays of hope in industrial but you are still going to be pretty cautious, I think as you put it, uneven expectations or expectation for the market to be uneven. Would you say that’s a different course than you had going into '13 where maybe you, if I recall, you guys sort of expected an improvement as you went through the year?

Gary Hendrickson

Right. I guess you could say we learned our lesson from '13, Bob, in terms of trying to predict. And prediction for us is conversations with our customers about markets that are uncertain. And so we are being cautious this year. The other thing that is different this year, about last year, is this horrible weather that we see. And I think it may have had a modest impact on both our paint, in current paint sales, and some of our industrial sales in the quarter. So we are being cautious. As an example, in our pipe business. We think some projects were delayed because the weather is so cold. In our coil coatings business, we know that we didn’t make some shipments to customers because they weren't producing because of the cold weather.

So in addition to macro factors, we are also kind of factoring in the weather this year and trying to understand what that’s going to mean for our industrial businesses. So we had a great '12, we had a '13 that we weren't happy with. '14, we are a little bit more optimistic but we are also being cautious.

Robert Koort - Goldman Sachs

And maybe along similar lines, I noticed last quarter for the first time you guys released some revenue guidance. I didn’t see an update for the annual revenue guidance this year, but it would strike me that may be that 7% to 9% could still be cautious given that we have seen some price hikes in the retail sector and Cat and Deere talk about some improvement in the off-roads markets in '14. So any shot you could give us, like a recalibration on that 7% to 9% revenue growth for this year.

James Muehlbauer

Yes, Bob, I tried to cover that as I kind of went through kind of a broader statement on our outlook. Really, we are not thinking about the top line any differently than we were at the beginning of the year. We put that range out there for the first time just given the nature of the significant new business that we had won last year and what we expect to do this year. So we hope that that’s a helpful view for shareholders to look at as they think about our performance for the year. But sitting here at the end of the first quarter there is a wide range of outcomes, but fundamentally we don’t feel different about that range than we did at the beginning of the year.

Operator

Next we will go to the line of Duffy Fischer with Barclays.

Duffy Fischer - Barclays Capital

I was wondering, you talked a lot about new business and some about volumes. Could you touch on the different end markets and what you are seeing around pricing and what your expectations might be for pricing for this year?

Gary Hendrickson

Pricing, Duffy, would -- I would say that it will be consistent with what our expectation for inflation are. And we said, our expectation for inflation, I think we said are low mid-single digits, which wouldn’t imply too much pricing. I will say that in some places where we have had inflation in different parts of our raw material basket, we are working with customers on moving pricing through the supply chain. But by and large, it's not a big factor in our thinking for the year.

Duffy Fischer - Barclays Capital

Okay. And then I assume it has something to do with the acquisitions, maybe some inventory step up. But inventory was up about 18% year-over-year, meaningfully more than sales. Could you walk through what the large jump in inventory was?

James Muehlbauer

Yes, Duffy, it's Jim. Primarily it was driven by, you are absolutely right, the acquisition of Ace. That was the biggest driver of inventory, but also the inventory--

Gary Hendrickson

Inver.

James Muehlbauer

I am sorry, Inver, the acquisition of Inver. Also the other elements that are driving the inventory increase would be just the build out of the Ace branded product and getting ready for the B&Q launch that we talked about.

Duffy Fischer - Barclays Capital

Okay. And then just the last one for me. Can you kind of update your thinking on B&Q? How the timing for that looks? And as we start looking for ads and stuff like that around the U.K., what we should expect to see?

Gary Hendrickson

Well, you'll start to see some advertising as we move into the selling season, late spring. We have got 100 stores set. It's kind of going in three phases. They have three store formats, Duffy, and we believe they got one store format just about completed. They are starting on the next one. And all of those 350 stores, we expect that things stay in schedule. We expect to have them all set by the end of the summer, early fall.

Operator

Next we go to the line of Dmitry Silversteyn with Longbow Research.

Dmitry Silversteyn - Longbow Research

Congratulations on a nice start to the year. Can you guys talk a little bit more about the sales and the profit impact of Inver, now that you had it for the second quarter. And sort of what's your outlook for that business is, given that it's a European centric business.

James Muehlbauer

Yes, Dmitry, it's Jim. If you recall, when we announced the Inver acquisition, we talked about an impact of roughly $0.10 for a year, comprised not only of the addition of the sales but also reflecting the benefits of some restructuring and synergy opportunities we have between the Inver business and our European operations. So as Gary mentioned in his comments, that integration process continues to go very well. The business has been performing in line to just slightly better than expectations since we owned it. So we are encouraged by the continuing top line progress in that business. It does trade at a lower EBIT multiple than our core businesses, which is why we are calling out kind of the overall dilution in our segment margins. But so far for the year, it's performing on plan and we continue to be encouraged by the opportunities we see to grow in that important market place for us.

Dmitry Silversteyn - Longbow Research

Okay, thanks. If you look at the, particularly the North American paint market where you have gotten double-digit growth in the quarter, could you strip out the Ace and the Lowe's impact in the sort of, look at the same-store basis. How did that business do for you and was their much of a weather impact for January or perhaps in December and what's your outlook for February and March of this year on same store, if you sort of get the....?

Gary Hendrickson

Yes. I would say, this is the lowest. Whenever you try to call out POS in December, January, February, Dmitry, it's kind of a gap. It's not as predictable as we do it in the spring and summer season. So I think probably, low mid-single digits across our distribution, would be an answer to your question. But we don’t have perfect visibility on all that data either.

Dmitry Silversteyn - Longbow Research

Fair enough. You mentioned getting some market share wins or customer wins in packaging space. The food can market has gone through material destocking at least by the people that actually make the cans, and particularly in Europe. Was that much of an impact in your business or is that still to be seen or sort of how do you think about the packaging business going forward. Obviously you are gaining share, so you can do better than the market, but what are you looking at the market itself.

Gary Hendrickson

Well, I think it's pretty well known to people that follow the packaging market that the U.S. market has contracted a little bit over the last couple of years. And that’s not a surprise to anyone who follows it. And the beverage, the beverage market however is growing in the Middle East, in Europe and Latin America, and in Asia, quite substantially. That’s where a lot of our market share wins have taken place over the last 12 months or so. And so, yes, we are probably growing through those wins three times the rate of the market growth in beverage.

In food, in Europe we took a pretty significant amount of share last year and while the, I think the market was down a little bit, our business was up mid-single digits in Europe. You know that we have a very strong position in North America food and so the impact that you described in terms of the customer destocking and a weak pack had an impact on our results in the quarter. So we are bullish on the packaging business in the long-term. It's a growth market globally. We are the leader, we are the technology leader. We are the leader in non-BPA technology which was the source of some of the share gains that we had in Europe food. So we wish it were growing faster but we are at a very nice position there.

Dmitry Silversteyn - Longbow Research

Very good, Gary. And then one final question. Just sort of returning to your comment about anniversaring the Valspar pickup at Lowe's as well as the Ace Hardware house paint. And it's like a poor growth in the balance of the year from the paint segment. You still have B&Q stores to ramp up in terms of sales in the second half of the year. It sounds like an obviously Valspar branded paint at Ace is still sort of on the comp, in terms of year-over-year comps. So even though your growth is going to probably slow down versus the channel fill that you referred to earlier, you should still -- I should ask this as a question, remember this is like jeopardy. Do you still see a little bit sort of faster than market growth in your paint segment just from some of these initiatives continuing and ramping up in B&Q and Valspar at Ace?

Gary Hendrickson

I will say that -- so I will answer the question this way -- I will be disappointed if the Valspar brand doesn’t grow faster than the market this year. Our expectation is that Valspar is going to grow faster than the market this year.

Operator

Next we will go the line of Don Carson with Susquehanna.

Don Carson - Susquehanna

Yes, I want to follow up on second half profit growth and specifically the Ace program. You had mentioned that you just thought that the rate of EBIT growth would slow as the year goes on, but I would think that as Valspar becomes a bigger part of your mix at Ace, and that’s where most of the profit is, that at least with the Ace program the profitability should pickup as the year goes on.

James Muehlbauer

Yes, it's Jim. That’s absolutely true. What I was commenting on was the run rate that we expect in the balance of the year in the paint segment is not expected to stay at the 250 basis point EBIT improvement expansion that we saw in Q1. So I know most people weren't thinking that at the beginning of the year. Certainly our plans don't reflect that. We will see a continued improvement in the EBIT margins from our business in paint for the reasons you mentioned but as I also mentioned in my comments, as we move in the painting season, we are supporting that new business growth with investments to support the brand and to support our retail partners as we do the launches at Ace, and as we continue to build the business with Lowe's together.

Don Carson - Susquehanna

And to follow up on Lowe's Pro. You mentioned you will be anniversaring that program next quarter, sometime in the second quarter. What's the actual organic growth potential or said another way, what potential do you see for contractors to do business at big boxes as opposed to paint stores. Do you think that’s a significant growth opportunity over time?

Gary Hendrickson

We do. As I have said before on these calls, Don, I mean we have got a committed partner and Valspar is very committed to their professional market. And I think that channel can support a significant with the professional, not every professional. And so if we segment the paint market into the various types of painters that are out there, there are some that that channel probably can't support but there is a very large portion of professional paint market that they can, with the right approach and the right partnership.

Don Carson - Susquehanna

Okay. And a final question on productivity. You refer to lots of productivity, are you still referring mainly to your North American manufacturing restructuring or is it also kind of encompassing the operating leverage you are getting because of these growth programs and better volumes?

James Muehlbauer

It was more focused on the operating leverage in growth programs right now. We will see continued improvements from our restructuring activities but those will scale as we get to the back half of the year.

Operator

Next we will go the line of PJ Juvekar with Citi.

PJ Juvekar - Citi

Just on coatings side, Gary, can you discuss your wood coatings business, particularly in China? I know that market went through a big downturn. Where are you on that market?

Gary Hendrickson

We are doing great in wood coatings in China. That business last year, PJ, was the one industrial business in our mix that had a really good year in China. We have got a great team, number one. People that have been involved in that business for over ten years, great stability in that team. A couple of years ago we integrated our warranty [ph] and the legacy Valspar team, I guess it was probably three years ago, under one leadership structure. So now we have got a team of people that can do business across the whole gamut of manufacturing companies in wood product lines. From the OEMs, the big ones that are doing contract work for U.S. furniture companies, to the small distributors in China, we have got the whole market covered. So we saw a nice growth, mid-single digit growth, and faster than mid-single digit growth in profitability. So we are pleased with that business. You are right, it's been a tough market, but we have been winning share and growing.

PJ Juvekar - Citi

Good, thank you. And you talked about this big channel fill at Ace and then you have your Valspar paint being sold there, you have the B&Q rollout. If you just bracket these two things together, B&Q and Ace, what could be the EPS impact from those two? Thank you.

James Muehlbauer

Yes, as we said earlier, PJ, we are not expecting a big impact on EPS from B&Q. That’s going to remain to be a diluted initiative for this year. And quite honestly as we move into next year, that’s more about proving out our brand and our model and our partnership, working together with B&Q. So we have never envisioned that as being a big driver of EBIT in the business currently. We will see how that business progresses. As we have talked before, as we move into the balance of this year with Ace, we are going to see improved profitability due to the addition of the Valspar branded product for the full year. Also, in the back half of the year we will start to get more synergies from our combined manufacturing efforts that will kind of finish the restructuring activity from the first half of this year. So we haven't called out the numbers specifically for the year but we are looking for that to be an accretive business for us in the balance of the year.

Gary Hendrickson

But it's not much. As we said on the last call, PJ, Ace is dilutive in the first half of the year, starts to become accretive as we move through the second half of the year. And as Jim said, B&Q is slightly dilutive for the whole year. And all of that’s built into our guidance.

Operator

Next we will go to the line of John McNulty with Credit Suisse.

Ernie Ortiz - Credit Suisse

This is Ernie Ortiz filling in for John. You have a decent amount of exposure to the non-residential cycle, I guess the coil and wood coatings section. Can you describe what you are seeing there? And any thoughts into the balance of the year, is there a recovery on the horizon?

Gary Hendrickson

Yes, Ernie, I don’t know that I agree with your premise that we have got a lot of exposure in that market in our paint and wood coatings business. We have a little bit in our coil coating business with prefab housing and things like that. But we expect, it was a pretty good market last year and we expect it to be a pretty good market this year. It has been impacted by the weather, as I mentioned in some of my earlier remarks that some of those projects are not happening on the pace that we expected. So I expect that to flow through but I really don’t have a good read on that market so I can't answer your question with any specifics.

Ernie Ortiz - Credit Suisse

Okay, that's helpful. And I guess, just lastly on the Australia front. Should we continue to expect you to outperform the market? And I guess what exactly are the thinkings for the market to grow out for the remainder of the year?

Gary Hendrickson

I think they are calling for the -- the Australian Paint Manufacturers Federation is calling for something like 2% to 3% volume growth in the Australian paint market this year. And we expect that we will outperform that. We did in the first quarter and we think we will see continued improvement in our business as the year goes on, both at trade and retail.

Operator

Next we will go the line of David Begleiter with Deutsche Bank.

David Begleiter - Deutsche Bank

Gary, first on paint margins, you mentioned some increased spending in Q2. With that increased spending can you still increase margins year-over-year in that segment do you think?

Gary Hendrickson

We expect that on a full year basis our margins will improve in the paint segment this year.

David Begleiter - Deutsche Bank

Very good. And same thing on coatings. Given the Inver impact, we are still looking at margins down year-over-year in Q2 given the Inver impacts or other impacts?

James Muehlbauer

Yes. Inver is going to continue to put pressure on net margins in the coatings segment until we anniversary it in the fourth quarter. We have a part where -- but remember we started booking that in, I think two of the three months in Q4 of last year. So we will see how the balance of the general industrial businesses play out as the quarters move on, but the main benefit will come from the anniversaries during the fourth quarter.

David Begleiter - Deutsche Bank

What were sales in Q1?

Gary Hendrickson

Somewhere around, it was around a $200 million business when we bought it. So divide that by four and that’s roughly what they were.

David Begleiter - Deutsche Bank

Just last, Gary. How is the M&A market looking right now from your perspective?

Gary Hendrickson

I don’t know about the market, David. I mean if you listen to the investment bankers that come around here you would think it was, we are on the cusp of a renaissance. But a lot of the things don’t come to fruition. We think about our opportunities, you know we did to very nice acquisitions last year with Inver and Ace, and we would love to be able to run our business at a pace, something like that a couple of years. And we are in contact with lots of people as I am sure the other paint companies are, and you just can't predict the timing, particularly with the private owners. You can't predict what the timing is if they decide to monetize their business. So I expect that you will continue to see consolidation in our industry. That’s been the trend for 20 years and there is still a lot of paint companies out there that will be owned by others as the years go by.

Operator

And our last question will be a follow-up from the line of Dmitry Silversteyn with Longbow.

Dmitry Silversteyn - Longbow Research

I just wanted to follow up and you actually touched on that in answer to an earlier question. But you are still on target to close the Ace store and one of your -- I mean plant and one of your plants, and consolidate the Ace production by middle of the year. That still is the plan?

Gary Hendrickson

All of our restructuring Dmitry, in the U.S., in Australia and in Europe, is right on plan for the year.

Dmitry Silversteyn - Longbow Research

Okay. And the closure of that of those plants is why you are looking for that step up in profitability and accretion from the Ace program, right?

James Muehlbauer

And the continued inclusion of the branded business as a bigger part of our sales base in the balance of the year.

Operator

And I guess we have more time for questions. We will go on to the line of Jeff Zekauskas with J. P. Morgan.

Jeffrey Zekauskas - J. P. Morgan

Was your volume growth rate in paints faster than your sales growth rate in the quarter?

James Muehlbauer

Yes.

Jeffrey Zekauskas - J. P. Morgan

By how much?

Gary Hendrickson

By about 600 points. And that’s a rough number, Jeff. And that’s a function of the fact that we are doing a private label business for Ace, the Lowe's Pro products at a lower price point and the rest of that mix. And the affordable housing market business which is quite a profitable business but has lower average selling prices than the deal than the overall mix that we are in. So that’s the reason you see that. I view that as a good thing.

Jeffrey Zekauskas - J. P. Morgan

In terms of the sales growth, you were up about 10% for the quarter in paints. Is it correct to think that maybe 60% of that was Lowe's and 40% of that was Ace, as a rough order of magnitude? Or Lowe's was 6 and Ace was 3, something like that?

Gary Hendrickson

No, no. In our segment, we were up significantly, high double-digit. And how do you say it, we were up a lot in China off of a weak first quarter last year. Over 30%, just to say the number. In Australia, we swung from negative to positive sales, mid-single digits.

James Muehlbauer

In local currency.

Gary Hendrickson

In local currency, right. And then the balance would be Ace and Lowe's but I would have to think about what the math is on that.

Jeffrey Zekauskas - J. P. Morgan

So what was the largest factor behind the sales growth of all of the different things you named?

James Muehlbauer

Yes, really two things. The continued rollout of the branded programs at Ace. It's the addition of the Lowe's Pro business, and it's the activity that Gary mentioned in China with the volume growth and the affordable housing market, were the three big drivers from a paint standpoint.

Jeffrey Zekauskas - J. P. Morgan

And then, lastly, if you look at your titanium dioxide consumption and you compare it to your volume growth in paints, was it more or less the same or did it grow at a faster rate or a slower rate?

Gary Hendrickson

If you are question, Jeff, is about are we continuing to get productivity on TiO2, maybe that’s your question, than the answer is yes. We are using less TiO2 across our business today than we were say a couple of years ago, as I think all paint companies and other consumers of TiO2. I mean this is what actually took place a couple of years ago and into last year to get more productive as the TiO2 pricing went up. So we are using less TiO2 in our formulas today than say we were two years or 2.5 years ago, for sure.

Operator

Next we will go the line of Charles Dan with Morgan Stanley.

Charles Dan - Morgan Stanley

Just wanted to follow up on Jeff's question a little bit. Since we are coming up on 12 months for some of your growth initiatives, is it possible for you to quantify in sales terms what those growth initiatives have done in the last 12 months in terms of revenue?

James Muehlbauer

Which initiatives are you talking about specifically, Charlie?

Charles Dan - Morgan Stanley

Valspar Pro at Lowe's, the Ace business and B&Q, which I know is still in very early days.

James Muehlbauer

Yes. I think so the B&Q, nominal impact. Obviously, just given its early nature. But if the Lowe's Pro, the addition of that last year had a meaningful impact throughout the year, remember we didn’t start that really until Q2. So that was a nice driver of growth for us last year. Even on a full year basis this year, it's going to be a nice addition as we anniversary it in Q1 but we also expect to continue to build on that success. And then the addition of the Ace business last year obviously from a base of zero with the private label business. Meaningful impact for the total company, coupled this year with the addition of the branded business on top of Ace. So a lot of the growth on an annualized basis this year is coming from the initiatives with Ace and the initiatives with Lowe's Pro. A nice element on top of that is that we continue to see benefits from the recovering housing market in our core business as well. So I highlight those big drivers but underneath of that, there is a nice steady, stable growth beat in our core paint business as well.

Charles Dan - Morgan Stanley

I guess you guys put a number out there of about $400 million a year from these programs. Do you have a sense for where we are relative to that number?

Gary Hendrickson

Yes, we are still saying that that number is a run rate number in '15, Charlie. That’s what we said and when we expect to be there.

Charles Dan - Morgan Stanley

Okay. And then, sorry, just had a question on capital structure. Where do you guys envision the steady state level of debt on the business as you look out to 2015 and beyond?

James Muehlbauer

So we are interested in remaining an investment grade company. If you look at our leverage ratios, they haven't changed materially over time. It provides us with an opportunity to continue to focus on growing the business. The good news is we have got plenty of capital to fund our growth initiatives while still being in the market looking at M&A transactions. We have firepower certainly to do that with the balance sheet while at the same time continuing the share repurchase activity that the company has done a nice job over the last few years. So we are not thinking materially different about the capital structure of the company going forward. I think embedded in that remains the opportunity for us to grow our business productively, both organically and through acquisitions.

Operator

Next we will go to the line of Steve Schwartz with First Analysis.

Steven Schwartz - First Analysis

I guess the first thing on Ace. You mentioned, Gary, that you expect to be in 3,000 stores which would be about two-thirds of the locations. I think when you took the private label or the Val branded opportunity over about a third of Ace stores, I think, already had a paint department with a brand in it. So can you parse out how many of the 3000 stores you will have actually didn't have a branded component in it before versus those that did?

Gary Hendrickson

So I think about 1300 of the 4000 plus stores had that brand that you are talking about.

Steven Schwartz - First Analysis

Yes.

Gary Hendrickson

I think that most of those 1300 will be part of our program. In fact I know the number to be in excess of 80% of those stores will either be taking our brand exclusively or in conjunction with that other brand.

Steven Schwartz - First Analysis

Okay. Well, that's good news.

Gary Hendrickson

Yes.

Steven Schwartz - First Analysis

That's good to hear. And then just as a follow-up, if I may beat a dead horse and hopefully you won't hold it against me, as you talk about the second quarter anniversary of the new programs, I think that kind of implies that you saw a revenue benefit from stocking over the past year for Lowe's Pro and perhaps the Ace private label manufacturing agreement. Can you quantify what that stocking contribution was to revenue?

Gary Hendrickson

No, I don’t think so, Steve. It's not material.

Steven Schwartz - First Analysis

Okay.

Gary Hendrickson

In Ace we ship to the warehouse and the warehouse ships to the Ace stores. At Lowe's we had a small load in at -- I guess in one month. But that ran through the P&L pretty quickly.

Steven Schwartz - First Analysis

Okay. Then why would you expect the anniversary to see drop off in growth if from day one you were seeing demand just from organic?

James Muehlbauer

Steve, I think we are talking about different points, right.

Steven Schwartz - First Analysis

Okay.

James Muehlbauer

So I think your question is talking essentially about initial load-ins that would go along with launching a new program. All we are trying to say is that, as we move forward in the year, we are going to anniversary having Lowe's Pro in the mix for a full year now, and Ace private label in the mix for a full year. So we are not....

Steven Schwartz - First Analysis

In the mix?

James Muehlbauer

In the mix, right. So we are not saying that we did a big load in Q2 last year. What we are saying is that we didn’t have those businesses at the same level in Q1 of this year so we when we get into Q2, just mathematically year-over-year the growth rate is going to come down.

Operator

And next we will go to the line of Rosemarie Morbelli with Gabelli & Co.

Rosemarie Morbelli - Gabelli & Co.

Good morning and congratulations. You talked about the issues with shipping containers. Could you talk a little bit about what you are seeing in the off-road markets? Have inventories come down at companies like Deere, for example? Do you see some kind of a pickup later in the year or is it a two years out type of project?

Gary Hendrickson

I wouldn’t expect it to be that far out Rosemarie, but reading some of our -- reading our customers comments, the large customers in that segment, I think inventories are in much better shape this year than they were last year. We expect we will be selling to a normal production volume. However, neither of one of the big companies are calling for a particularly positive year. One of them reported this morning and I think I am right to say that they called out volumes to be more of a flat for the year. So that’s the approach that we are taking with our business, is that we are going to approach it cautiously and we are going to manage our cost and we are not going to get too far out on the limb in terms of promising growth in that particular segment. I will say, though, that China is a different story. In China, we have seen a pretty significant pickup in activity in that market with some factories that were closed last year now producing vehicles. So that’s a positive sign. The only thing that’s to it, is that we are not static in that market. It's a large global market and we have a relatively small position of a large global market. So our teams are out winning new business in that market. And a big part of the reason that we are seeing improvement in our China business is, is business that we are doing with local manufacturers, as well as the multinationals. So I expect it to be a better year than last year but I don’t expect it to have a material impact on the company.

Rosemarie Morbelli - Gabelli & Co.

Okay. That is helpful. And I was wondering we always talk about Asia and Australia, can you remind me what kind of a business you have in Asia outside of those two major geographies? Or is it so small that it doesn't fall down to the bottom line or the top for that matter?

Gary Hendrickson

Asia and Australia. I am sorry?

Rosemarie Morbelli - Gabelli & Co.

I mean outside of Australia and China. You know, everyone is talking about growing in Southeast Asia, not really doing much in China. The two regions are kind of separated and I was wondering how big a business you had in Southeast Asia?

Gary Hendrickson

Well, we have a nice packaging business in Southeast Asia. We do some off-road business in Southeast Asia. And then we do wood coatings business in Southeast Asia. We have got a plant in Malaysia and we do business in all of the ASEAN countries. So I can't pull the exact number off the top of my head but it would probably be -- Southeast Asia would be 10% to 15% of our mix in Asia-Australia.

Rosemarie Morbelli - Gabelli & Co.

And is it growing much faster than Australia and China?

Gary Hendrickson

Well, remember the segments that I just mentioned, packaging, which is growing. The packaging market in Southeast Asia is growing maybe 10% a year, something like that. We are participating in that as a leader in that industry. And the wood coatings market is growing as well I think. As manufacturers have left China and moved to Southeast Asia to get around the anti-dumping regulations on bedroom furniture, Southeast Asia has grown for us in our wood business, particularly Vietnam.

Rosemarie Morbelli - Gabelli & Co.

Okay. No, that is very good. And if I could have a couple of quick housekeeping questions. Are we looking at interest expense levels for the next three quarters to be similar to that of the first which would give us about $64 million for the full year?

Gary Hendrickson

Probably between $16 million to $17 million a quarter will be kind of the run rate.

Rosemarie Morbelli - Gabelli & Co.

Okay. And same question for the share buyback. I know that you usually aim to lower your basic numbers of shares or the fully diluted share by 2% a year. The stock today is very strong. Are we expecting the number of shares for the full year to be similar to that of the first quarter or do you think that you will add to your repurchase?

James Muehlbauer

Yes, Rosemarie, we continue to think of that as an opportunity for us to build value for shareholders. As you know over the last couple of years we have purchased in excess of the 2% amount that you mentioned. So we see that as a continued part of our growth story and we think it's a great way to not only enhance shareholder returns while we invest in our business but also to demonstrate the confidence that we have in the ability to grow this business profitably for the long term.

Rosemarie Morbelli - Gabelli & Co.

Okay, that is helpful. And lastly, the tax rate for the full year?

James Muehlbauer

Unchanged. 32% to 33%, Rosemarie.

Operator

And at this point we are out of time with questions.

Tyler Treat

Thank you. Thanks to everyone for participating in the first quarter earnings conference call. Follow-up questions from investors and analysts can be directed to me, Tyler Treat. My contact information is on the morning's press release. Thank you and that concludes our call.

Operator

And Ladies and gentlemen, this conference will be made available for replay after 12:30 p.m. today, through February 26. You may access the replay system at anytime by dialing 1-800-475-6701 and entering the access code of 316362. International participants may dial 320-365-3844. That does conclude your conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

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The Valspar Corporation (VAL): FQ1 EPS of $0.70 beats by $0.04. Revenue of $956M (+9.2% Y/Y) beats by $7.39M.