The Valspar's (VAL) CEO Gary Hendrickson On Q2 2014 Results - Earnings Call Transcript

May.19.14 | About: The Valspar (VAL)

The Valspar Corporation (NYSE:VAL)

Q2 2014 Results Earnings Conference Call

May 19, 2014, 11:00 am ET

Executives

Tyler Treat - Treasurer, Vice President of Investor Relations

Gary Hendrickson - Chairman of the Board, President, Chief Executive Officer

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

Analysts

Dan Jester - Citi

Bob Koort - Goldman Sachs

Kevin Hocevar - Northcoast Research

Ghansham Panjabi - Baird

David Begleiter - Deutsche Bank

Ernie Ortiz - Credit Suisse

Dmitry Silversteyn - Longbow Research

Jeff Zekauskas - JPMorgan

Duffy Fischer - Barclays

Vincent Andrews - Morgan Stanley

Steve Schwartz - First Analysis

Nils Wallin - CLSA

Rosemarie Morbelli - Gabelli & Company

Don Carson - Susquehanna Financial

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Valspar's fiscal 2014 second quarter earnings call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions). Also as a reminder, today's teleconference is being recorded.

At this time, I would turn the conference call over to our host, Treasurer and Vice President of Investor Relations, Mr. Tyler Treat. Please go ahead.

Tyler Treat

Good morning and welcome to our fiscal 2014 second 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 will 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 risks and uncertainties. Our SEC filings contain additional information about factors that could cause actual results to differ from management's expectations. These filings could be found in the Investor Relations section of our corporate website at valsparglobal.com.

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 release.

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

Gary Hendrickson

Thank you, Tyler, and good morning, everyone. We are pleased to report a good quarter in which sales increased 10% and adjusted EPS increased 18%. These results reflect continued momentum in our business and are consistent with the growth plans that we set for the fiscal year. Last year, we lost a number of growth initiatives in both the paint and coatings segment. Strong execution of these initiatives in fiscal 2014 is driving our performance.

In the second quarter, we completed a number of key milestones against these initiatives including completing the supply chain integration in Europe for our general industrial product line, which was enabled by the Inver acquisition. This includes a consolidation of three manufacturing locations which will substantially improve the cost structure and create a strong foundation for future growth in the European market.

Earlier this month, we jointly announced with Lowe's the launch of Valspar Reserve interior and exterior paints, which are available exclusively at Lowe's. Valspar Reserve outperforms competitive products at similar price points based on attributes that matter most to consumers. Reserve incorporates our most advanced color technology and offers best-in-class durability. Together with Lowe's, we are jointly supporting this exciting product launch with in-store merchandising and increased advertising.

Moving now to the independent hardware channel. Over 3,000 Ace stores have been redesigned and reset with the Valspar retail program, which exceeds our original expectations. The completion of these redesigned Ace paint departments puts Valspar in a great position ahead of the painting season. Execution of these initiatives have been a priority for this year and we are very pleased with our results so far.

I will now turn to several other highlights in the quarter, starting with the coating segments' improved trends and profit in sales. In packaging coatings, we continue to grow volume and increase our global market share. Our European business performed very well with volume growth in the high single digits including significant growth in non-BPA coatings. We have an industry-leading sales position in non-BPA coatings and expect further growth as customer preference for this technology develops.

In Asia, double-digit growth was driven by increased market demand and new business wins. In North America, despite low single-digit declines in the beverage can market, we grew our volume in the low single digits. Sales in the general industrial product line were up 2% over last year, excluding Inver and currency. This is a solid improvement against the backdrop of uneven regional and end market demand. Slight declines in the U.S. were offset by market growth and new business wins in China and Europe. Speaking of Europe, Inver continues to perform well and, as I just mentioned, we are doing a great job of capturing the operational synergies from this acquisition.

Our wood product line remains a strong performer benefiting from new business wins in China and the U.S. and improving U.S. housing market. The only product line in coatings that underperformed this quarter was coil, where sales finished lower than the previous year due to harsh weather in the U.S. We expect to recover similar weather-related delays in the back half of the year. So looking back at the first half of the year, we are pleased with our progress in the coatings segment. We are executing well against our growth initiatives offsetting tough external market conditions in some regional markets.

Moving now to our paint segment. We delivered another good quarter in all regions and total sales increased 8%. This performance was primarily driven by double-digit volume growth in the U.S. As you know, over the last few years we have launched several significant initiatives to grow the Valspar paint brand. We have successfully partnered with Lowe's on a number of new programs over that time, like the Love Your Color Guarantee, the expanded Pro program and now Valspar Reserve this spring.

The launch of Valspar Reserve provides another opportunity to grow sales with shoppers who value the benefits of a super premium paint and to build on our premium brand image with consumers. We are increasing our year-over-year investments in advertising to support Valspar Reserve with Lowe's and grow the Valspar brand in general. The rollout of the Valspar branded Ace was another driver of increased sales in this segment. We are pleased to have our brand so well-positioned in the Ace network in advance of this year's paint season.

Our paint segment also had a solid quarter in international markets. In China, we continue to benefit from new products and distribution that serve the affordable housing market, a large and growing market. In Australia, we had another quarter of positive sales growth in local currency and recent third-party data indicates that we are building market share in both trade and retail channels.

In summary, we continue to execute well on our growth initiatives and our operating plans for the year. Our priority is to invest in these initiatives and leverage our strong market positions to drive profitable growth. We have managed a number of accretive initiatives in our company over the last 18 months or so. This testament to the capability and commitment of Valspar employees that we successfully completed the integration of Inver, launched Valspar Reserve in partnership with Lowe's, reset over 3,000 Ace stores and substantially completed our global restructuring program. At the same time, while this was happening, we stay focused on our customers and markets and were growing our company. These efforts are translating to improve top and bottom line performance through the second quarter and we continue to expect annual adjusted EPS in the range of $3.95 to $4.15 for fiscal 2014.

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

Jim Muehlbauer

Thanks, Gary. This morning I will review the key drivers behind our performance in the second quarter and discuss our expectations for the balance of the year, starting first with our performance in Q2.

Sales growth of 10% was led by volume gains in both our coatings and paint segments. These gains were driven by acquisitions and new business wins in many product lines. Looking at performance in the paint segment, sales increased 8%. Growth was led by double-digit volume gains in the U.S. from the continued rollout of Valspar branded products at Ace as the number of stores converted to the branded paint program increased. We also increased sales in the home improvement channel, driven in part by the launch of Valspar Reserve.

Consistent with our plans, growth in Q2 paint shipments to customers in the home improvement and independent hardware channels was comprised of initial orders for new products like Valspar Reserve and new inventory for the redesigned paint departments in Ace stores. The shipments in Q2 will support customer demand expected during the upcoming paint season.

Switching now to our international regions. Paint sales in China were up slightly in Q2, after very strong growth in the first quarter. Year-to-date sales in China are up over 20% as we build momentum with our paint products that target the affordable housing market and as we compare against lower sales volumes from last year. In our Wattyl business, sales in local currency increased low single-digit. The paint business in Australia and New Zealand has trended in an improved direction for each of the last four quarters.

Moving on to the coating segment. Sales increased 12%, driven primarily by the Inver acquisition. Excluding acquisitions, coatings sales increased 2% which was a sequential improvement over the previous quarter when sales declined slightly. We had another solid quarter of mid single-digit volume growth in our packaging product line, reflecting volume increases from the U.S., Europe and Asia. Excluding currency, total packaging sales increased slightly in the quarter. Wood product line sales increased mid-single digits in both China and the U.S. from the combination of new business wins and improvement in the U.S. housing market.

Continuing with the coatings segment, sales in the general industrial product lines, which includes pipe, off-road equipment, industrial finishes and containers continue to reflect uneven end market demand. General industrial sales in Q2 were up 2% in local currency. This trend is a significant improvement from last year and improved sequentially from Q1.

Coil product line sales declined mid-single digits in the second quarter as building construction projects were delayed by very difficult weather conditions in the U.S. We expect to recapture a portion of these sales in the balance of the year.

Shifting now to gross margins. We finished the quarter with consolidated gross margin of 34.4%, an improvement of 90 basis points over last year. Similar to last quarter, the increase in gross margin was driven by improved sales mix, leverage benefits from higher volumes and productivity initiatives in both the paints and coatings segments.

During last quarter's call, we discussed plans to increase spending in support of our various growth initiatives. Consistent with these plans, SG&A expense in the second quarter increased to 110 basis points to 21% of sales. The increase in spending versus last year was a result of three main drivers. First, our expense growth included the addition of the Inver acquisition and Ace. Second, we have increased investments to support new retail initiatives in brand building activities in the paint segment. These include higher advertising, marketing and support expenses for these programs. And finally, we had higher variable incentive compensation expense in the quarter. We expect this to continue through the balance of the year with the largest impact occurring in the third quarter.

Bringing it altogether, operating income increased 9% and operating margins finished at 13.4% in the second quarter. From a segment perspective, paint's EBIT of $57 million was down slightly from the prior year. This was the result of planned spending increases on the retail growth initiatives we discussed earlier. In addition, much of the incentive compensation increase versus the prior year was in this segment. Year-to-date sales and EBIT in the paint segment has increased 9% and 11% respectively.

In the coatings segment, second quarter EBIT of $101 million increased 21% over the previous year. The increase in EBIT was the result of Inver and benefits from leveraging higher sales volumes and improved productivity. As Gary mentioned, we have executed well against the key initiatives we laid out at the beginning of the year. These activities included several restructuring initiatives to improve our operations and lower costs. Through the first half of the fiscal year, pretax restructuring charges totaled $21 million, which was in line with our plans for these activities.

Wrapping up the highlights from the quarter, we repurchased approximately 1.5 million shares of the company stock for a total investment of $108 million.

Now looking to the balance of the fiscal year. As Gary said, we are pleased to confirm our annual adjusted EPS guidance in the range of $3.95 to $4.15. Additionally, there are a few items having a bearing on our earnings growth between Q3 and Q4, which are factored into this guidance. In the third quarter, we will continue to increase investments in the Valspar Reserve launch with Lowe's and our other growth initiatives. The third quarter's incentive compensation expense will be significantly higher than last year as we expect better operating results this year.

Also a reminder that we will report 53 weeks this fiscal year. So for fourth quarter will have an extra week versus last year. We estimate that the extra week represents approximately $30 million and almost 3% of additional sales growth in the fourth quarter.

Before we move into Q&A, I am very pleased to introduce our new Vice President of Finance and Investor Relations, Bill Seymour. Bill comes to Valspar with a strong track record of investor relations experience in a variety of industries. We welcome Bill to the Valspar team and I know he is looking forward to meeting with you in the near future.

As many of you know, in addition to working on investor relations, Tyler Treat is also Valspar's Treasurer. Tyler will continue with his treasury role, as well as some broader responsibilities within our finance team. I would like to thank Tyler for his leadership and in many contributions to Valspar's Investor Relations program.

With that, we would like to open up the call for your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will come from PJ Juvekar with Citi. Please go ahead.

Dan Jester - Citi

Good morning. This is Dan Jester, on for PJ. There seems to be a lot of negative headlines out of the Chinese property market but, as you mentioned in your prepared remarks, you have grown the business and volumes nicely both in this quarter and the past. So what are you seeing on the ground today in China and what are your expectations for the rest of the year?

Gary Hendrickson

Yes. Good morning, Dan. It's Gary. We read the same newspaper articles that you do and my perspective on it is, if it is not 8% any longer that's too bad, but 7% is pretty good relative to most other places in the world. Our performance this year in China has been very good. The way we look at it is that Valspar has low share in all of the business segments in the China market that we operate in. So we have lots of room to grow. Our perspective is that even if we got a flat market, we should be growing our market share, which is what we are doing so far this year and have historically done.

One reminder, relative to our results in the first quarter and first half of this year is that, we had a pretty soft quarter in paints last year, this quarter and also in the first quarter. The reason for that was that at the end of 2012, we launched our non-exclusive product for the affordable housing market and our distributors took a lot of orders for that in 2012 that they then sold through in the first half of 2013, so against a pretty soft comparison.

That being said, all of our businesses in China this year are growing substantially. In fact, our overall China business this year is up in the mid-teens with our general industrial business, our coil business, our packaging business, our wood business and our Waran paint business, all doing well.

So I guess to answer in short, I would answer your question by saying the property market is not as robust as it has been in the past, but there are segments of it that are growing including the affordable housing segment and we are well-positioned in that segment to take advantage of both the growth in the market and in market share growth.

Dan Jester - Citi

Great. Thanks. That's helpful. Then just quickly on CapEx. First half, $51 million, much higher year-over-year. It seems like a little bit different than the typical back-loaded trend that you see for capital spending during the year. So is there anything driving that specifically and how should we think about CapEx over the balance of 2014? Thank you.

Jim Muehlbauer

Yes, Dan. This is Jim Muehlbauer. Our CapEx in the first half also reflects the completion of some projects that we started last year around new paint manufacturing facility in the China market and investments that we have made in our worldwide R&D capabilities, principally with the new facility or expanded facility here in the U.S. So the front-end load of CapEx really reflects the completion of those big projects.

I guess as we think about our capital spend in general, we have been investing in growth initiatives in both the coatings and paint segment. Gary talked about a number of the restructuring activities that we launched last year and that we are getting towards the end of those projects in the current fiscal year. So we are happy to deploy capital against those rationalization activities in the supply chain, while at the same time investing in growth in our businesses. So we look forward to spending more capital against high returning projects for our shareholders as time goes forward.

Dan Jester - Citi

Great. Thank you.

Jim Muehlbauer

Thanks, Dan

Operator

Thank you. Our next question in queue will come from Bob Koort with Goldman Sachs. Please go ahead.

Bob Koort - Goldman Sachs

Hi. Thanks, guys. Just wondering two things. One, you talked about the seasonality in the coil business. I guess I didn't realize that was such a just in time business that maybe your demand would be so closely linked when buildings are actually being erected. So could you talk a little bit about that and why you didn't call that out on the paint side?

And then secondly, I was wondering if you could just give us some update on what the pricing dynamics are on the architectural paint businesses around the world? Thanks.

Gary Hendrickson

Okay. Good morning, Bob. Our coil business in North America, at least, is a make to order business and our customers, we had a number of instances that over the quarter where our customers, they couldn't get steel in because of supply chain disruptions, or for other reasons just because of the weather they had to close. So that had an impact on our business.

I guess, really, the only reason we called it out is because it was the only significant product line in the company that didn't grow in the quarter and we wanted an opportunity to say that. So we called it out. Weather is not an excuse. We had a good quarter, notwithstanding the difficult weather we had in North America, but we called it out for that reason.

In terms of pricing dynamics, in the consumer businesses, we have taken price in Australia. There has been some raw material inflation in Australia as the Australian dollars depreciated. In China, no pricing. In North America, sequentially we saw some increase in our raw material costs in the quarter, but there hasn't been any significant pricing in our channels in North America.

Operator

Thank you. Our next question in queue will come from the line of Kevin Hocevar with Northcoast Research. Please go ahead.

Kevin Hocevar - Northcoast Research

Hi. Good morning, everybody.

Jim Muehlbauer

Good morning, Kevin.

Kevin Hocevar - Northcoast Research

Just wondering in the paints segment, as you look out to the balance of the year, segment earnings were down a little bit this quarter and it sounds like higher incentive comp and higher investments are here to stay, at least for the third quarter. Would you expect to grow earnings for the rest of the year? Or do you think we will still be flattish, maybe down a little bit due to the incremental investments?

Jim Muehlbauer

Yes, Kevin. Our plan is to, certainly for the entire year, in the paint segment to grow earnings. You correctly call out that we continue to plan to increase our investment spend during the paint season. So you are going to see more expense in Q3 but it's really behind the growth initiatives that we laid out at the very beginning of the year. So the phase in of our earnings in the paint season for the year is playing out halfway through the year, a lot exactly what we thought. We have got a long way to go with the back half of the paint season in front of us here, but for the year in total, we continue to expect to increased total earnings in paints.

Kevin Hocevar - Northcoast Research

Okay, and then in terms of B&Q, how is that rollout going? Is it still the expectation, I think, the fall timeframe you should be in 350 stores and also in the 100 or so stores you are in today. Are those stores performing better in terms of paint than the stores that don't have Valspar? Just wondered if you could comment on that?

Gary Hendrickson

Yes. Kevin, Gary. I think we are in about 100 and close to 200 stores right now. It's 190 something out of the 350. We still expect to be in all of the stores sometime in the fall. Certainly by the end of the year, we will be positioned in all of the B&Q stores. Initial feedback from the stores that have been reset is that the consumer acceptance of the Valspar program is very strong and B&Q is working as quickly as I can to convert the rest of stores.

Kevin Hocevar - Northcoast Research

Okay. Thank you very much.

Gary Hendrickson

You are welcome.

Operator

Thank you. Our next question in queue will come from Ghansham Panjabi with Baird. Please go ahead.

Ghansham Panjabi - Baird

Hi, guys. Good morning.

Gary Hendrickson

Good morning.

Ghansham Panjabi - Baird

First off, could you just touch on your interpretation of the state of the U.S. housing market? Obviously data has been very mixed. Lots of noise from the weather, maybe interest rates as well. Gary, what do you think is going on in the market? Any warning signs that you are seeing or you just think that the quarter was impacted by weather overall?

Gary Hendrickson

Well, I think the housing market, the trend line in both existing home sales and new construction is a positive one. It's not a sharp line up to the right, but I think the market overall is improving. We see the results of that in our wood coatings business as an example, which is having another good year on the back of a good year last year and that's the one of our businesses. The industrial business is most closely correlated to North America housing market.

We are positioning ourselves for a good year, Ghansham. As Jim mentioned, we are increasing and we had planned at the beginning of the year and we are on our plan to increase advertising for the Valspar brand at retail. We just launched a great product with Lowe's Valspar Reserve at a price point well above $40 and initial results on that product are encouraging. So we were expecting to have a strong back half of the year in paints and the businesses that are related to U.S. housing.

Ghansham Panjabi - Baird

Okay, and then maybe a question for Jim. In terms of the variability in SG&A, Jim, what do you think the right level of SG&A as a percentage of sales should be over time? Just wondering.

Jim Muehlbauer

Well, I think you have to look at the segments separately. As we are investigating in growing the brand in the paint segment, the opportunity that we have is to continue to increase consumer awareness and drive trial of the Valspar brand. We get a great benefit this year of doing it with much broader distribution in the portfolio.

So two things you see happening this year, Ghansham. You see the introduction of the business at Ace, which is now going to be supported with advertising investments from a launch standpoint this year. There will clearly be some, as we go forward as well. And we are launching a new business or a new product line in Valspar Reserve with Lowe's.

So we are happy to spend that advertising against the paint business to grow awareness and to grow our share in the marketplace and I think as we continue to look at different markets across the world, given the growth trajectory that we see that the potential in China for paints and coming off a period of time with more experienced in the European market with B&Q, I think give us an opportunity to leverage it overall. So I see us continuing to invest in those spaces and it's difficult to give you the exact SG&A expense right now because it is variable on two pieces, right. How fast is the sales growth pickup and how can you leverage that expense and how much spending is going to be required as we get more feedback on what the market acceptance of those products are.

But the key punch line is, we expect expenses in paint to grow, from a dollar standpoint, as we invest behind the brand, but we should be able to continue to leverage that investment growth with higher sales.

Ghansham Panjabi - Baird

Okay. Got it. Thanks so much.

Jim Muehlbauer

Thanks, Ghansham.

Operator

Thank you. Our next question in queue will come from David Begleiter with Deutsche Bank. Please go ahead.

David Begleiter - Deutsche Bank

Thank you. Gary, very strong results in coatings this quarter. Looking at Q3, given the improvement in productivity and the acquisitions, should we see 18% plus operating margin in coatings in Q3?

Gary Hendrickson

Yes, we don't talk about discrete quarters, David. I mean, I think we are going to have a strong margin profile in coatings for the full year, above last year, but I am not going to speculate on what it might be in any particular quarter. , I think, last year it was something like 17% or so, because it's a historically high quarter in terms of volumes and we get the operating leverage from it, but I would rather not to talk about what the exact number we are expecting in any given quarter.

Jim Muehlbauer

Yes, and the key thing is, we expect EBIT margins to expand for the full year in the coatings segment representing those exact thing that you talked about, David. The productivity improvements, but also the leverage we are getting from higher sales over last year.

David Begleiter - Deutsche Bank

Understood. Gary, just on TiO2, just your current initiatives to reduce usage and pricing expectations looking at for the rest of the year.

Gary Hendrickson

The answer is, I don't think about TiO2 much anymore. We have done a nice job of substituting somewhere in the high single digits over the last three years or so, David. I know we are buying 40% or so from China. The quality in China improving over time. There is lots of capacity. There is lots of inventory. So it's just not a commodity that I pay much attention to anymore, to be honest with you. I let my purchasing people take care of that.

David Begleiter - Deutsche Bank

Thank you very much.

Gary Hendrickson

You are welcome.

Operator

Thank you. Our next question in queue will come from John McNulty with Credit Suisse. Please go ahead.

Ernie Ortiz - Credit Suisse

Hi, good morning. It's actually Ernie Ortiz, filling in for John. Just had some questions. Can you quantify the magnitude of the higher marketing spend in paints in the quarter? And how should we think of that number going in to 3Q?

Jim Muehlbauer

Yes, similar to what Gary had mentioned earlier, we are not going to get into the details of our marketing spend as against our channel partners, quarter-by-quarter. We have got planned all year long to support the launch of Valspar Reserve and Ace with increased marketing spending. You saw that happen in the second quarter as we started to rollout some of the expenses. We expect that the third quarter, given the fact that we are in the prime paint season in third quarter, to see those expenses increase even higher year-over-year.

The other element that I called out in my prepared comments is, we have a pretty big headwind on incentive compensation expense. As you may recall, last year in Q3, we basically wound back our earnings expectations for the year and turned back incentive expense. This year, we certainly plan to perform better. So on a year-over-year basis, that increase in incentive compensation is being broken out into our paints and our coating segment. That year-over-year increase is probably going to be biggest in the paint segment overall.

So for the combination of increased spending in the paint season in Q3 and higher year-over-year incentive expenses, we compare to a more normalized level and we expect expenses to go up even more in Q3.

Ernie Ortiz - Credit Suisse

Okay. That's helpful. And then, you also call that inclement weather in coatings. How much did weather impact you in the quarter? And would you say that demand is back to normal now, as you see in April and May demand trends?

Jim Muehlbauer

It is hard to know exactly how much demand impacted us in the quarter. It was specifically in the coil business, a little bit in our protective coatings business as well and we get that primarily from the production patterns of our customers as we called on our comments as well. We expect that a good portion of that's going to fall in to the back half of the year, but until we get through the whole back half of construction season, it's difficult to call out exactly how much that could be.

The key thing for us overall is our job is to manage the entire portfolio to deliver expectations. We are always going to have ebbs and flows on things that will be a little bit better than we plan, a little bit worse than we plan, and we are trying to manage the total which is what we have certainly done for the first half of the year.

Ernie Ortiz - Credit Suisse

All right. Thank you. Appreciate the help.

Jim Muehlbauer

Thanks.

Operator

Thank you. Our next question in queue will come from Dmitry Silversteyn with Longbow Research. Please go ahead.

Dmitry Silversteyn - Longbow Research

Good morning, guys. It's still morning and congratulations on another strong quarter. A couple of questions, if I may. Your Ace rollout is going well and you admitted that you are suppressing sort of your goals for how many stores were going to accept the program. With over 3,000 stores now going forward, at maturity should we be looking at a dollar value from this business that's above $100 million to $150 million that you originally guided for this business?

Gary Hendrickson

I think so.

Jim Muehlbauer

Yes, Dmitry, and the $150 million was a run rate number by FY 2015. So we always expected that we were going to go north of that $150 million number but things are progressing well.

Dmitry Silversteyn - Longbow Research

Okay. Your introduction of paint at Lowe's, obviously the Pro paint that you introduced last year and this new premium brand that you are introducing this year. How is it affecting your overall growth rate at Lowe's? Our understanding was that, given the weather, the DIY channel, perhaps felt it a little bit more than the contractor channel, but you, I think, commented on seeing some growth at Lowe's business this quarter. So can you comment on how much of that was new business versus maybe offsetting some of the weakness of the older business? Or is the legacy business still growing?

Gary Hendrickson

So I talked about it in my prepared remarks, as we set our channels for the paint season, we are launching new products with the Valspar Reserve and certainly we built out, if you look quarter-over-quarter, we have put another 1,500 Ace stores in play with the Valspar paint program.

So, Dmitry, a part of our shipments in the second quarter reflect the initial stocking of both of those items, and really as we look at consumer offtake that's going to play out in the back half of the year as the paint season gets rolling. A good chunk of our sales in the quarter in the paint segment really reflect the initial sets of both of those programs.

So it's difficult to tell where the overall consumer uptick is going to be. We are going to have to wait till the end of the third quarter to get a better read on that. But we are where we thought we would be and we are pleased with the sets that we have in both of those channels so far this year.

Dmitry Silversteyn - Longbow Research

Okay, and then one final question, if I may. Your other segment, not so much on the topline but then the operating line has been showing some lumpy negative profitability and then you have got your corporate expense in there. So if I put it together with your comments about third quarter having incremental spending in advertising and things like that, should I be looking at the other year-over-year comp being negative again versus being slightly positive last year, I think?

Jim Muehlbauer

Yes, you should. The primary reason for that, Dmitry, is that we have got a portion of the incentive compensation expense that flows through that other segment as well as it relates to corporate employees.

Dmitry Silversteyn - Longbow Research

Right. Okay. Thank you.

Jim Muehlbauer

Thank you for your questions.

Operator

Thank you. Our next question in queue will come from Jeff Zekauskas with JPMorgan. Please go ahead.

Jeff Zekauskas - JPMorgan

Good morning.

Gary Hendrickson

Good morning, Jeff.

Jeff Zekauskas - JPMorgan

Your paint sales were up about 8%. Is that about how much volumes were up? How much did volumes increase relative to sales?

Gary Hendrickson

Slightly more than that, Jeff.

Jeff Zekauskas - JPMorgan

Slightly more. Second, your depreciation and amortization expense, I think, was a little bit more than $28 million in the first quarter.

Gary Hendrickson

Yes.

Jeff Zekauskas - JPMorgan

This quarter it was $24.5 million.

Gary Hendrickson

Yes.

Jeff Zekauskas - JPMorgan

Why was it so much lower? And what's the reasonable number for the remainder of the year?

Jim Muehlbauer

Yes. So we are looking at total depreciation and amortization of around $100 million for the total year, Jeff.

Jeff Zekauskas - JPMorgan

$100 million.

Jim Muehlbauer

Yes.

Jeff Zekauskas - JPMorgan

Okay.

Jim Muehlbauer

Depreciation and amortization total, $100 million for the year, which isn't different than what we have been talking about all year long. The change in the run rate that you mentioned from Q1 to Q2 is that as we have been executing some of the rationalization activities in the North American and European supply chain with manufacturing facilities, we accelerated depreciation in advance of the closure of some of those facilities and now that those facilities are closed, they are essentially getting off the books.

Jeff Zekauskas - JPMorgan

That's interesting. So you will be $23 million, $24 million for each quarter.

Jim Muehlbauer

Which is kind of what is this quarter.

Jeff Zekauskas - JPMorgan

Why year-over-year were your receivables and inventories up so much? I think inventories were up about 15% and receivables maybe 20% and receivables really had very big sequential increases. What's going on there?

Jim Muehlbauer

A couple of things. The main driver behind the increase in inventory is the addition of Inver in the portfolio. I would say the addition of Inver, coupled with the new business at Ace and what we are doing in rolling the launch of B&Q, those initiatives alone represent about 90% of the inventory increase year-over-year.

AR is primarily a training issue, as we relate, I should say timing item not a issue, related to the shipments I talked about earlier in Q2 as we loaded in those new paint programs for Valspar Reserve and at Ace and we got a lot receivables for stuff that we just shipped over the last 30 days, a lot of which will turn as we move into Q3.

Jeff Zekauskas - JPMorgan

What was your operating cash flow in the quarter?

Jim Muehlbauer

Year-to-date, operating -- just let me look it up here, Jeff.

Jeff Zekauskas - JPMorgan

Okay.

Jim Muehlbauer

Because what I wanted to was, I want to pullout restructuring expenses from that.

Gary Hendrickson

Jeff, we will have Tyler give you a call a little bit later with the exact number.

Jeff Zekauskas - JPMorgan

Okay. Great. Thank you so much.

Jim Muehlbauer

Thanks, Jeff.

Operator

Thank you. Our next question in the queue will come from Duffy Fischer with Barclays. Please go ahead.

Duffy Fischer - Barclays

Yes. Good morning. On that the European business, where we are converting the BPA, I will call BPA free, but its not quite free, but the BPA free, how far along that process have we come, and in general, on bids that have been won, how is your market share on those bids compared to your market share in Europe currently?

Gary Hendrickson

I am not sure I understood the second part of it, Duffy, but I will say, number one, it is BPA free. These are new technologies that we have developed over the last five to seven years that are winning market share in Europe and in North America, primarily in the food business and the general packaging business, but also in the beverage business, and I think Valspar is a leader. With this technology, we are a leader in packaging and coatings. We have invested well over $100 million in developing non-BPA coatings over the last, as I said, five to seven years and we are positioned extremely well for our customers and brand owners, if they have a desire to move to a non-BPA alternative.

Duffy Fischer - Barclays

But I guess my question was, what percentage of the total market you think might move in Europe has already moved and how much of that has moved if you look at North America and Europe, those two geographies, how much of that rollover have we seen to the BPA free?

Gary Hendrickson

I would be speculating on how much will move and the market share of non-BPA coatings is still relatively small but for us, it has been growing pretty dynamically.

Duffy Fischer - Barclays

Okay, and then just a question on the inventories again. With the inventories going in for Reserve, when will, I guess, inventories stop building in that channel? And might we hit a lull next year as that inventory build rolls over where sales don't grow as fast for a couple of quarters?

Jim Muehlbauer

Yes. We are working with our channel partners all the time to match inventory levels in their network, in our network to meet forward demand. So a little early to talk about what inventory is going to do next year. We have done a nice job historically managing that relationship. Going into the paint season with the new product launches and the store sets that we have for Ace that took place, we certainly have much higher inventories right now and basically what we are doing is that we are building in advance of all the new product launches an opportunity to sell more branded paint.

We have got more advertising that we are going to have in the marketplace in the back half of this year than we had last year. So for a combination of all those reasons, we believe it is prudent to have the right amount of paint available on the channel to meet demand. But from an overall standpoint, I think Q2, you will see the peak inventory levels in the business, which is consistent with historical seasonality.

Duffy Fischer - Barclays

Great. Thank you, guys.

Jim Muehlbauer

Thank you.

Operator

Thank you. Our next question in queue that will come from Vincent Andrews with Morgan Stanley. Please go ahead.

Vincent Andrews - Morgan Stanley

Thank you. A quick question on Europe. Europe had a much easier winter than we did here in the States. Could you just talk about how much, if any, of the positive impact that had and are you still seeing the trends in Europe continue into this quarter?

Gary Hendrickson

Yes. We didn't see any weather impact in Europe, Vincent. Europe was a bright spot for us in the quarter and it has been has been all year. Our packaging and coatings business is growing nicely as we mentioned. The Inver acquisition has been a success story for us. Inver is growing. Our general industrial legacy business is growing. Our coil business is growing. Those are the three main businesses, coil, GI and packaging that we are in Europe and all three businesses are running a nice trajectory now, growth trajectory, and I expect that that will continue for the rest of the year and then into next year.

Vincent Andrews - Morgan Stanley

Okay, and then just a follow-up on the spending in the third quarter versus fourth quarter. I recognize you don't give guidance but it sounded like the increase in spending in the third quarter might put you in a situation where the EBIT level could be flattish and then you would see more growth in 4Q to allow the full year to grow. Is that the right cadence?

Jim Muehlbauer

Yes. We are expecting more EBIT growth in Q4 versus Q3 for the reasons I mentioned earlier around increased promotional spending in the paint segment in Q3 plus its our toughest comparison period on incentive compensation in total.

Vincent Andrews - Morgan Stanley

Fair enough. Thanks very much.

Jim Muehlbauer

Thanks, Vincent.

Operator

Thank you. Our next question in queue will come from Steve Schwartz with First Analysis. Please go ahead.

Steve Schwartz - First Analysis

Hi. Good morning, guys.

Gary Hendrickson

Good morning, Steve.

Steve Schwartz - First Analysis

With respect to the Lowe's Pro program, it sounds like a few of your competitors, both in the stores channel and in the home centers channel, are making a stronger push toward the contractors. Has that forced you to change your outlook on the potential of that program?

Gary Hendrickson

No. We had competitions within the channel last year when we launched the program, Steve, and we still have competition in the channel. We also obviously have competition from the legacy players in the stores business. Not much has changed. There is another party being supported, I think by the Home Depot that wasn't there at the time that we launched our program last year, but it's still channel competition. So our point of view on the market and our ability to participate on it hasn't changed. We all know that the Pro market is growing faster than the DIY market and we feel that with Lowe's that we are position nicely to capture growth.

Steve Schwartz - First Analysis

Okay, and then with the VAL branding at Ace, the uptake there has been very nice. Do you think that cannibalizes at all the manufacturing portion or arrangement you have with them? In other words, to the earlier question that hinted the $400 million target for these programs, should we see the uptake of the VAL brand as being additive to that? Or are you still really sticking to the $400 million?

Gary Hendrickson

Well, I think Dmitry asked the question earlier, Steve, about the specific to Ace and we called it out as $100 million to $150 million opportunity that would be included in the $400 million that, I think, you are referring to, which was a combination of Ace, Lowe's Pro and B&Q, but specific to Ace, as Jim and I said earlier, the program has gone better than expected and we have more retailers that want to carry the Valspar brand than we initially modeled. So we expect that that the Ace program should be larger than we first anticipated

Steve Schwartz - First Analysis

Okay. Great. Thank you, Gary.

Gary Hendrickson

You are welcome.

Operator

Thank you. Our next question in queue will come from Nils Wallin with CLSA. Please go ahead.

Nils Wallin - CLSA

Good morning, and thanks for taking my question. In your volume growth in the U.S., was that entirely due to new business wins and underlying growth? Or are you taking share from competitors?

Gary Hendrickson

It's a combination of both, Nils. In a couple of markets, we did see some recovery. We saw some recovery, as Jim mentioned, in our infrastructure market, which is pipe coatings. We see recovery in China in the off-road segment. Those were two areas of weakness for us last year. So there is some underlying market growth

But we have an internal metric which we call net new business, which is business won versus business loss and that was a positive number in the mid-single-digit this year in both coatings and paints. So we are also taking some market share.

Nils Wallin - CLSA

Got it, and your two programs that you got in Lowe's, the Reserve and obviously the Pro do you anticipate those will cannibalize any of the legacy business? And if so, what would that do to the margin structure there?

Gary Hendrickson

We wouldn't expect that the Valspar Reserve, which is at is very high price point, would cannibalize anything from the Pro which is at a much lower price point. So zero cannibalization there. We were hoping for trade up with Valspar Reserve relative to -- we would like to see some cannibalization if you like to use that word. The other two price points that we have at Lowe's, we would like to see consumers trade up to the best paint that think they can afford and that's part of our plan.

The Valspar Reserve is designed for those consumers who want a super premium paint, who can afford a super premium paint and are willing to pay for the attributes of a super premium paint brand. Some of those people didn't have an option last year and they would have been buying our other products. So we are happy that we provided that option for them this year and that would be cannibalization

We also expect that there will be new consumers that are drawn to Lowe's to buy Valspar Reserve because it is a demonstrably better paint than alternatives a similar price points.

Nils Wallin - CLSA

Got it, and just one final one, if I may. Have you started to see any switch between the private-label brands or some of the other competitors at the Ace stores into your Valspar brand?

Gary Hendrickson

Too early to tell, Nils. It's too early to tell. We are really just entering that. We will be able to answer that question in five months or so after the paint season is done.

Nils Wallin - CLSA

Understood. Thanks again for taking my question.

Gary Hendrickson

You are welcome.

Operator

Thank you. Our next question in queue will come from Rosemarie Morbelli with Gabelli & Company. Please go ahead.

Rosemarie Morbelli - Gabelli & Company

Good morning, all, and all thanks for taking my question. I was wondering if you could spend some time on Australia. In Australia, could you bring us up-to-date on how many more stores Masters has built? Whether the profitability at Wattyl stores, now that you are done with your restructuring, whether it is at a level you like? And then if you could talk about the market in general?

Gary Hendrickson

I think, in order, Rosemarie, I think Masters has something in the high 40s.

Jim Muehlbauer

45 stores.

Gary Hendrickson

45 stores that are built now. The paint department at those stores is performing well. As you know, we have most of the shelf space with Valspar at the super premium price point and the legacy Wattyl brands at most of the other significant price points. It's right on plan. We are very pleased with it.

In our trade business, as Jim said, we have grown our volumes for the last four quarters and the independent research that has been published in Australia says that we are gaining share in the trade segment. So that's a positive. Our EBIT margins are not at our terminal target but they are much improved over last year and the business has tremendous operating leverage.

The market housing market, which is pretty good, to answer your third question about market. As the housing market continues to recover and we put volume through our cost structure, we are getting tremendous operating leverage out of that.

Rosemarie Morbelli - Gabelli & Company

Sounds like great news. Thank you. And I was wondering if you could talk about your can coatings in the U.S. versus the can coatings in Europe. Are you selling more of one category in one region versus the other? And what are you seeing there? I think you said that you had lower can coatings in the U.S. but did very well in Europe. So are we talking food versus beverage? Can you give us a better feel for that?

Gary Hendrickson

In our prepared remarks, Rosemarie, I think I said relative to North America that the beverage market volumes were down, the market volumes were down, which has been a fairly consistent trend as consumers shift the way to alternative types of packaging and alternative products away from soft drinks. That's a trend that we understand and expect it, but that our volumes were up notwithstanding the decline in a market volume. So that's a positive story in North America.

And in Europe, where volumes, overall can volumes were up somewhat, our volumes were up much higher than the market volumes were. Also a positive story. So we are pleased with our performance in both North America and Europe, by the way, and in Asia, where we had a quarter in our Asia business. The only region of the world where our growth was flattish was Latin America, and that's largely because we are big supplier of the market in Venezuela and we haven't been able to get our product in.

Rosemarie Morbelli - Gabelli & Company

Okay. Thanks, and if I may ask one quick last question. On the paint side, how much would you say is for interior paint as opposed to exterior paint, on the consumer paint?

Gary Hendrickson

It's roughly 80/20, interior, exterior, Rosemarie.

Rosemarie Morbelli - Gabelli & Company

Okay. Thank you.

Gary Hendrickson

You are welcome.

Tyler Treat

Tony, we will make this the last question.

Operator

Thank you, sir, and that question will come from Don Carson with Susquehanna Financial. Please go ahead.

Don Carson - Susquehanna Financial

Thank you. A couple of questions. Just on the 10% U.S. growth, how much of that would be organic versus pipeline fill? And then on the overall promotional spend, obviously it's going to be up in 2014 versus 2013 but as you get into 2015, does this promotional spend go away at least on the existing platform rollouts and hence you get a lot more operating leverage? Maybe just talk about the cadence of spending as you go into next year?

Gary Hendrickson

Well, the first question, Don, about half of the growth was the pipeline fill and half was what you call organic. That's normal growth.

Going into 2015, we are just going to have to wait and see. We try to have a pretty consistent investment profile in our brands globally over the last couple of years. This year, we have lifted that spend a bit because, in the case of Ace, we have more business that supports it and in the case of the Reserve launch, we want to make sure that consumers are aware that there is a fantastic paint available to them at Lowe's and so we are going to spend appropriately to make sure that that message gets out.

Next year, we will have different programs. We will tailor our spend to the situation that we have next year in terms of new product news and promotion and other things that we want to do in our mix. So we are not ready to talk about 2015 yet, except to say that we are going to continue to invest in the Valspar brand and our Cabot brand because those are great brands that consumers know about today. We want more consumers to know about them.

Don Carson - Susquehanna Financial

Thank you.

Operator

Thank you. At this time, I will turn the conference back over to our presenters for any closing comments.

Tyler Treat

Thanks, Tony. Thanks to our audience for participating in our second quarter earnings conference call. Follow-up questions from investors and analyst in the short-term can be directed to me, Tyler Treat. My contact information is in this morning's press release. Bill Seymour's contact information will be up on our website in early June and then Bill will be the point of contact. Thank you, and that concludes our call.

Operator

Thank you, and ladies and gentlemen, this conference will be available for replay after 12:30 PM Central Time today running through June 2 at midnight. You may access the AT&T Executive Playback Service at any time by dialing 800-475-6701 and entering the access code of 325132. International participants may dial 320-365-3844. Once again, those phone numbers are 800-475-6701and 320-365-3844, using access code of 325132. That does conclude your conference call for today. We do thank you for participation and for using the AT&T Executive TeleConference. You may now disconnect.

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