The Sherwin-Williams' CEO Discusses Q3 2011 Results - Earnings Call Transcript

Oct.25.11 | About: The Sherwin-Williams (SHW)

The Sherwin-Williams (NYSE:SHW)

Q3 2011 Earnings Call

October 25, 2011 11:00 am ET

Executives

Sean P. Hennessy - Chief Financial Officer and Senior Vice President of Finance

Christopher M. Connor - Chairman and Chief Executive Officer

Robert J. Wells - Senior Vice President of Corporate Communications & Public Affairs

Analysts

Gregg A. Goodnight - UBS Investment Bank, Research Division

Jeremy Brunelli

Ivan Marcuse - KeyBanc Capital Markets Inc., Research Division

Charles Edward Cerankosky - Northcoast Research

Brian Maguire - Goldman Sachs Group Inc., Research Division

Stephen F. East - Ticonderoga Securities LLC, Research Division

Nils-Bertil Wallin - CLSA Asia-Pacific Markets, Research Division

Christopher J. Nocella - Barclays Capital, Research Division

Eric Bosshard - Cleveland Research Company

Eugene Fedotoff - Longbow Research LLC

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

Greg Melich - ISI Group Inc., Research Division

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Daniel Jester - Citigroup Inc, Research Division

Nils-Bertil Wallin - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Operator

Good morning. Thank you for joining the Sherwin-Williams Company's review of the third quarter 2011 financial results and expectations for the full year. With us on today's call are Chris Connor, Chairman and CEO; Sean Hennessy, Senior Vice President, Finance and CFO; Al Mistysyn, Vice President, Corporate Comptroller; and Bob Wells, Senior Vice President, Corporate Communications and Public Affairs. This conference call is being webcast simultaneously in listen-only mode by Vcall via the Internet at www.sherwin.com. An archived replay of this webcast will be available at www.sherwin.com beginning approximately 2 hours after this conference call concludes and will be available until Monday, November 14, 2011, at 5:00 p.m. Eastern Time.

This conference call will include certain forward-looking statements as defined under U.S. federal securities laws with respect to sales, earnings and other matters. Any forward-looking statement speaks only as of the date on which such statement is made, and the company undertakes no obligation to update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. A full declaration regarding forward-looking statements is provided in the company's earnings release transmitted earlier this morning.

After the review of third quarter results, we will open the session to questions. I will now turn the call over to Bob Wells.

Robert J. Wells

Thank you, Claudia. As always, in order to allow more time for questions, we provided balance sheet items and other selected information on our website, at sherwin.com, under Investor Relations third quarter press release.

Summarizing overall company performance for the third quarter 2011 versus third quarter 2010, consolidated net sales increased $312.7 million or 14.4% to $2.48 billion due primarily to selling price increases, acquisitions and improved organic volume growth by our Paint Stores Group and Global Finishes Group.

Acquisitions increased consolidated net sales 4.1% in the quarter, and favorable currency translation rate changes added 1% to net sales.

Consolidated gross profit dollars increased $66.7 million to $1.04 billion. Gross margin decreased 290 basis points to 41.8% of sales from 44.7% in the third quarter last year.

The decrease in gross margin was primarily due to higher year-over-year raw material costs and the dilutive effect of acquisitions completed during the past 12 months.

Selling, general and administrative expenses for the quarter increased 8% to $760.2 million due primarily to incremental SG&A from acquisitions, higher service costs resulting from increased sales and currency translation rate changes. As a percent of sales, SG&A decreased to 30.6% in the third quarter this year from 32.4% last year.

Interest expense decreased $858,000 compared to third quarter last year, and consolidated profit before taxes in the quarter increased $4.9 million or 1.9% to $250.3 million.

Profit before tax as a percent of sales decreased to 10.5% from 11.8% last year. Our effective tax rate in the third quarter this year was 30.9% compared to 31.4% in the third quarter of 2010.

For the full year 2011, we expect our effective tax rate to be in the low 30% range, excluding any impact of the IRS settlement, compared to last year's rate of 31.8%.

Consolidated net income increased $4.6 million to $179.9 million compared to $175.3 million in the third quarter of 2010.

Net income as a percent of sales declined to 7.2% from 8.1% in the third quarter last year.

Diluted net income per common share for the quarter increased 6.9% to $1.71 per share from $1.60 per share in 2010. Acquisitions and favorable currency translations combined had no significant impact on diluted net income per common share in the quarter.

Looking at our results by operating segment, sales for our Paint Stores Group in the third quarter increased 10.2% to $1.42 billion. Selling price increases and improving domestic architectural paint sales volumes across most customer segments accounted for most of the increase in sales.

Comparable store sales, that is sales by stores opened more than 12 calendar months, increased 8.2% in the quarter compared to the third quarter last year.

Regionally, in the quarter, our Southwest division led the sales performance, followed by Midwest division, Southeast division and Eastern division. Sales by all 4 Paint Stores divisions increased in the third quarter compared to last year.

Segment profit for the group increased $11.8 million or 5.2% to $236.9 million in the quarter as sales growth from selling price increases and volume improvement was partially offset by higher year-over-year raw material costs and selling, general and administrative expenses. Operating margin decreased to 16.7% from 17.5% in the third quarter last year.

Turning to our Consumer Group, sales in the third quarter increased 3.3% to $351.6 million due primarily to selling price increases that were partially offset by the elimination of a portion of a paint program with a large retail customer.

Segment profit for the Consumer Group decreased $18.7 million or 31% in the quarter to $41 million due primarily to higher year-over-year raw material costs that were partially offset by selling price increases and reductions in selling, general and administrative expenses.

Segment profit as a percent of external sales decreased to 11.7% from 17.5% in the same period last year.

For our Global Finishes Group, sales in U.S. dollars increased 31.2% to $714.4 million in the quarter due primarily to acquisitions, selling price increases, higher paint sales volume and favorable currency translation rate changes.

In the quarter, acquisitions increased Global Finishes Group net sales in U.S. dollars by 16.3%, and favorable currency translation rate changes increased sales in U.S. dollars by 3.2%.

Third quarter segment profit increased $11.6 million or 36.3% to $43.5 million. Higher paint sales volume, price increases, good expense control and favorable currency rate changes were partially offset by higher raw material costs and the negative effect of acquisitions.

Currency rate changes increased segment profit by $3.6 million, while acquisitions reduced segment profit by $2.5 million.

As a percent to external net sales, segment profit increased to 6.1% in the quarter compared to 5.9% in the third quarter last year as selling price increases and higher sales volume outweighed the increase in raw material costs.

Turning briefly to the balance sheet. Our total debt on September 30, 2011, was $1.169 billion compared to $1.066 billion in the third quarter of 2010.

Our cash balance at the end of the quarter was $46 million compared to $64.9 million at the end of third quarter last year.

Total borrowings to capitalization were 41.7% at the end of the quarter versus 39.4% at the end of the third quarter 2010. Short-term borrowings increased $162.9 million over third quarter last year to $517.5 million.

Long-term debt to capitalization was 23.2% at the end of the third quarter this year compared to 26.3% last year.

In the third quarter 2011, we spent $28 million on capital expenditures, depreciation expense was $38 million, and amortization expense was $10.1 million.

For the full year 2011, we anticipate capital expenditures will be approximately $150 million to $160 million, depreciation will be approximately $150 million and amortization will be about $30 million.

I'll conclude my remarks for the quarter with a brief update on our status on Lead Pigment Litigation.

On September 8, 2011, the Mississippi Supreme Court, in an 8-0 decision, overturned the jury verdict in the Gaines case and rendered judgment in favor of Sherwin-Williams. Previously, a jury had awarded the plaintiff $7 million for alleged injuries claimed to having resulted from ingesting Sherwin-Williams lead-based paint. The plaintiff asked the court to reconsider its decision, however, we believe it is unlikely the court will change its unanimous ruling.

That concludes my review of our third quarter results, so I'll turn the call over to Chris Connor, who will make some general comments and highlight our expectations for the remainder of the year. Chris?

Christopher M. Connor

Thank you, Bob. Good morning, everybody. Thanks for joining us. I think our third quarter results were encouraging in many respects, and I'll elaborate more in a moment, but first, let me take a few minutes to address the 8-K we filed last night.

Following the market close yesterday, we announced that we reached a settlement with the Internal Revenue Service regarding their audit of our employee stock ownership plan for the 2003 through 2009 tax years. You may recall from the 8-K we issued back in May, as well as the subsequent note in our second quarter 10-Q, Sherwin-Williams received a notice of proposed adjustments from the IRS, challenging certain ESOP-related federal income tax deductions and proposing substantial excise taxes and penalties. The settlement announced yesterday fully resolves all IRS issues relating to federal and state income taxes, including interest, though will result in an after-tax charge totaling approximately $75 million or $0.72 per common share and a reduction in shareholders' equity of approximately $51.2 million, both of which will occur in the fourth quarter. These charges were not included in Sherwin-Williams' previous fourth quarter and full year 2011 earnings guidance.

Although we do not believe the deductions in question violated any tax laws, we firmly believe this resolution is in the best interest of our shareholders. This is a one-time charge that will increase our effective tax rate for the current year only and will not affect rates in future years.

Importantly, this settlement avoids the potential for years of management distraction and eliminates future risk and uncertainty.

Third quarter 2011 was a record quarter for Sherwin-Williams. Revenues of $2.48 billion make this the largest sales quarter in our company's 145-year history, and $1.71 per share is an all-time high watermark for earnings per share in any quarter.

I think the most encouraging aspect of our results was the progress we’ve made in growing sales and volume. After backing out acquisitions and favorable currency, consolidated sales were up more than 9% in the quarter, and volumes increased both sequentially and compared to last year.

All 3 segments reported higher year-over-year revenues, and Paint Stores Group and Global Finishes Group delivered solid organic volume growth.

On our last call, we've said we expected domestic market conditions to improve in the second half compared to the first and that market volume would likely turn positive. Even assuming modest improvement in the market, the sales and volume performance of our Paint Stores Group in the quarter is convincing evidence that our continued investments in new store openings and superior store staffing is translating into market share growth.

Our strategic investments outside North America are also bearing fruit. For the third quarter and 9 months of 2011, our Global Finishes Group recorded positive volume growth across all lines of business.

SG&A spending increased $56 million in the quarter, however, our core SG&A expense, net of acquisitions, was up a little more than half that amount. Most of this core increase supported new stores opened in the past 12 months. The balance went towards maintaining staffing levels in existing stores and funding organic growth in our Global Finishes Group.

In total, we reduced year-over-year SG&A as a percent of sales by 180 basis points, which partially offset the significant increase in raw material costs.

Our disappointment in the quarter is that we're still being impacted by the rapid increase in raw material costs. The recent decline in petrochemical feedstocks, such as propylene, will provide some cost relief in the coming quarters. However, the pricing actions by the titanium dioxide producers are likely to continue for the balance of the year and in to 2012.

Despite our efforts to help offset these higher input costs, including around the price increases that went into effect in early October, the lag between raw material cost inflation and higher effective pricing has pressured our gross margin in the second and third quarters and will again in the fourth.

Implementation of our price increases is progressing as expected, and we remain confident that we will ultimately close the gap on input costs, but our margin results in the interim are nonetheless disappointing.

Although the input cost headwinds continue to suppress our earnings, we managed working capital efficiently and generated strong net operating cash in the quarter.

In the third quarter, we generated $338 million in net operating cash compared to $241 million in the third quarter last year, bringing our 9-month net operating cash to $446 million. The increase in the third quarter cash was primarily due to $100 million reduction in working capital. Nine-month free cash flow, net operating cash less CapEx and dividends, was $233 million. We continue to invest the company's cash to expand our control distribution platform, complete appropriate acquisitions, increase our dividend and purchase shares of stock for treasury.

During the quarter, we bought back 2.64 million shares of our common stock in the open market at an average price of $74.26, bringing our year-to-date total to 4.24 million shares.

On October 19, last week, our Board of Directors approved a new share repurchase authorization for an additional 20 million shares.

In the first nine months, our Paint Stores Group added 31 net new stores, 13 of which were opened in the third quarter. This brings our total store count in the United States, Canada and the Caribbean to 3,421 stores compared to 3,368 one year ago. Our plan continues to call for Paint Stores Group at approximately 60 net new store locations during the year. A number of store closings in the year will be more in line with our typical low to mid-single-digit pace.

On July 1, we completed the acquisition of Leighs Paints based in Bolton, England. Although relatively small in annual revenues, Leighs brings some very important technology to our global protective and marine product lines. Leighs is a market leader in intumescent or fire-protective coatings. When applied to structural steel or concrete, these coatings prolong the building structural integrity in a catastrophic fire, which provides more time for evacuation. Intumescent coating specifications are increasing globally, and we have high expectations for this new addition to the Sherwin-Williams family.

While it appears that overall, architectural demand in most market segments in the Americas and global demand for most industrial coatings should remain positive over the balance of the year, raw materials will remain a challenge for the foreseeable future.

Our outlook for the fourth quarter 2011 is for consolidated net sales to increase 6% to 10% compared to last year's fourth quarter. We expect fourth quarter diluted net income per common share to be in the range of $0.67 to $0.87 per share before the one-time charge of $0.72 per share relating to the IRS settlement, all compared to $0.67 per share in 2010.

For the full year 2011, we expect consolidated net sales to increase in the low-teens percentage range compared to last year. With annual sales at that level, we are reaffirming our 2011 full year guidance for diluted net income per common share to be in the range of $4.65 to $4.85 per share before the IRS settlement or in a range of $3.93 to $4.13 per share due to the settlement compared to $4.21 per share earned in 2010.

Finally, last week, our Board of Directors declared a regular quarterly dividend of $0.365 per share, up from $0.36 last year, which completes our 33rd consecutive year of increased dividend.

Again, I'd like to thank you for joining us this morning, and now we'd be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is coming from the line of Stephen East with Ticonderoga Securities.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Chris, if we look at the TiO2 outlook, what you talked about, I appreciate the commentary. One, what are you all seeing coming through the pipeline, and two, what type of alternatives do you all have? And I know we've talked about this in past quarters, but are you to the point where there are other sources that can move the needle or different formulations, that type of things?

Christopher M. Connor

Yes, I think we've commented, Stephen, that our expectations for the industry is that raw materials would finish for the year somewhere in the high teens, the low 20% range. Clearly, titanium has been the driver primarily of that growth this year, and we see numbers from other analysts in the range of around 40% year-over-year pricing in titanium. I don't think much change is in this forecast relative to how the year tracks regarding those numbers. 2012 remain to be seen, the amount of pricing, but from my earlier comments, you can see that we expect to be dealing with titanium price increases going into next year. Sherwin-Williams, our competitors and other raw material suppliers have all spoken about various replacement technologies, but I think the reality is that our industry is going to be relying primarily on this important raw material for a long period of time to get to come [ph].

Stephen F. East - Ticonderoga Securities LLC, Research Division

From a geographic perspective, are you seeing alternatives in sourcing that could make a difference in 2012?

Christopher M. Connor

Again, I think we've talked publicly about some of the emerging titanium producers and technologies around the world, and some of those are, in fact, winding their way into our operations. But again, I don't think there's substantial enough volumes to make a significant difference in the overall market environment.

Stephen F. East - Ticonderoga Securities LLC, Research Division

Okay. And then just the other question I have is on the consumer side. Your margins got pushed down quite a bit. Is this -- do you see it as a lack of pricing power or just really trailing, having a much longer time in getting those pricing through?

Sean P. Hennessy

Yes, Stephen. This is Sean Hennessy. Just talking about the consumer margins in the quarter, one of the things that happened this year is we really changed the production plan and really front-loaded our production plan for the year, which resulted in higher inventory in the first and second quarter. And what happened in the third quarter is our inventory in this area came down. It was reduced. So usually, you'll see that in the fourth quarter. So what happens is that in the third quarter, our inventory production plan was lower versus last year's third quarter, so the operating margin was depressed in the third quarter. And our fourth quarter margin will not drop sequentially at the same rate as last year's. Couple other effects of that was the cash. You saw, as Chris made his notes, cash was up over $100 million, and that was a direct -- correlated exactly to the same issue.

Operator

Our next question is coming from the line of P.J. Juvekar with Citi.

Daniel Jester - Citigroup Inc, Research Division

This is Dan Jester sitting in for P.J. I just want to talk a little bit about the sort of segments of your business that are more industrial-focused, like maybe product coatings or protective marine. Have you seen any slowdown sort of given what we've seen in the broader economy over the past few months?

Christopher M. Connor

No, Dan, those businesses are performing fine for the company. They tend to be more at the higher end of the kind of volume numbers that we've been talking about.

Daniel Jester - Citigroup Inc, Research Division

Okay, great. And then in terms of the price increase you announced in October, could you just give us a sense of how large that is? And then looking back to the June price increase, how much of that has been implemented, and can you give us a trajectory for how you expect the rest of that price increase to go through?

Christopher M. Connor

The October price increase was announced through our stores organization. I think as the investment community know, that's the one that we're usually the most transparent on. The pricing was around 8% to 9%. That's on top of pricing taken, as you mentioned, earlier in the year. In fact, this was the fifth price increase that we've taken in the last 20 months. All told, those 5 price increases cumulatively amount to just shy of around 30%. Historically, our net effective tax -- net effect of price increase has been in the 75% range of what we've gone out for. This last price increase is off to a good start and tracking right in line with those past historic performances.

Operator

Our next question is coming from Bob Court with Goldman Sachs.

Brian Maguire - Goldman Sachs Group Inc., Research Division

This is Brian Maguire on for Bob. Just on that last question on the price increases, one of your peers talked earlier this week about some price fatigue setting in with customers, and you mentioned this is the fifth price increase in the last 20 months. And I'd imagine those conversations get harder each time. What are you kind of seeing in the channel, maybe more in the consumer business than in your own stores? How are your customers downstream adjusting to all these, and how much of the announced price increases do you expect to get going forward?

Christopher M. Connor

Yes, I'll take the first half of this, and then I'll let Sean comment as well. Clearly, there's price fatigue. There's price fatigue on our part as well dealing with the raw material cost pressures that keep coming in. The frequency of the pricing activities that we've just talked about, again, as a reminder, is through our stores organization, so we don't take pricing as frequently to some of the other customer segments. We tend to go in smaller increments and more frequently, and I think as we've shared with the investment community over the years, the unique business model that we have servicing professional painting contractors and through our own stores, we strive [ph] a little better, run the market for us to implement them. Sean, I know you got some thoughts as well.

Sean P. Hennessy

Right. I think we need to take a look at -- I'd just like to point out a couple of numbers. If you look at the operating margins, really, in the stores group, we were down 8/10 in the third quarter, but for the 9 months, we're 2/10 below last year. I do think that there probably is some fatigue, but I think that gives you some comfort that pricing is going through and we're managing through that.

And again, when you take a look at the consumer margins, as Steve asked earlier, our margin year-to-date is down over 300 basis points. But I think that's going -- again, that was due to some timing of production and inventory. By the end of the year, I think that will be tremendously closer than it is today. So I think those numbers give you some kind of comfort that we're really starting -- we're still able to have pricing power in the market.

Brian Maguire - Goldman Sachs Group Inc., Research Division

Okay, great. And then just a follow-up on the inventories. How are your levels now compared to kind of normal seasonality, and would you expect to be doing some more prebuying or differentiated normal seasonal patterns on your inventory build if you expect raw materials to continue going up? Is there any thought of maybe taking advantage of the seasonal slowdown in the industry and building some inventories in the fourth or first quarters?

Sean P. Hennessy

Yes, finished goods inventories, when you go back 2 years, really, because last year, we had different kinds of finished goods inventory problems. But if you look at it compared to 2 years ago, we feel pretty good about our finished goods inventory. With the reduction in the third quarter, we're probably real close to where we should be. Raws, on the other hand, are slightly higher, and I think you pointed that out. And I would suggest that we're going to run high until we start to see the raw materials turn. And that's how we're managing that. But I think you're going to see raw materials higher in the short term.

Operator

Our next question is coming from Greg Melich with ISI Group.

Greg Melich - ISI Group Inc., Research Division

I wanted to get at little bit more into the timing of the progression of gross margin. If you look in the quarter, how much of the sequential 100 bps gross margin was the production issue? Was that basically all of the issues, Sean?

Sean P. Hennessy

No, but it was the majority when you look at that 100 basis points. And I think that what we look at in the third quarter was -- that's really going to be the lowest gross margin that we'll report on a quarterly basis this year. And we actually think that sequentially, you'll see our gross margin rise in the fourth quarter. And If I was to give you a forecast, we're at 42.7. Year-to-date, I think we'll get close to the low end of the range that we talked about, the 43 to 46.

Greg Melich - ISI Group Inc., Research Division

Got it. And the fourth quarter, qualitatively, that progression improvement, is that coming from the production shift, or does it actually come from the raw material pricing playing out the way it should?

Sean P. Hennessy

I would say it has a lot to do with the pricing. As Chris has mentioned, we just put a price increase the first week in October in stores, but we are going to have some positive because it's going to basically -- we had to take the positives or the negatives some time with the production plan. We took it in the third quarter versus fourth last year, so that will help us in the fourth quarter.

Greg Melich - ISI Group Inc., Research Division

Got it. And if I can have just one more question on the acquisition, I think in the past, you talked about adding maybe $450 million in total sales, but we lost a little money in the quarter related to acquisitions. Is that $450 million still the right number? Is there a sign of any volume shifts in Europe, in particular, that should be aware of?

Christopher M. Connor

No, that's a good number, Greg. We're tracking right on it.

Sean P. Hennessy

I think the loss, Greg, really, when you take a look at it, came from the acquisition we completed in the third quarter, the acquisition, the inventory step-up and so forth. Really, 100% of the loss actually came from the lease acquisitions that Chris mentioned during his comments.

Operator

Our next question is coming from Chuck Cerankosky with North Coast Research.

Charles Edward Cerankosky - Northcoast Research

Chris, when you look at the pricing resistance issue a little more, can you differentiate between how architectural contractors are dealing with paint price increases versus industrial contractors, especially in North America?

Christopher M. Connor

I don't think there's a lot of difference between the 2, Chuck. I think we're blessed with a customer, in both of those segments, who appreciates quality materials. They're loyal to that, have a higher labor component to a finished job and just the material cost. For the most part, pricing actions across both those segments are tracking as they have historically for us.

Charles Edward Cerankosky - Northcoast Research

Okay. And then following up on the volumes, could you talk about in Paint Stores and Global where you saw the volume increases, which end markets were strongest, and can you be a little more quantitative about how high volumes did increase?

Christopher M. Connor

Yes, I'll give you kind of a color on the segments and customer pieces, then I'll let Sean comment a little bit on just to get you closer in kind of the numbers. In terms of the stores business, as you know, we break out DIY as one big group. Within the contractor segment, we break out pretty much across all the other pieces, parts.

And as we've been commenting for some time, the residential repaint activities are the strength of the market. We've seen that. Obviously, DIY is essentially a residential repaint market in and of itself, but the painting contractor segment that's focused on that has continued to show some signs of strength for the company. We were pleased to see some growing signs of vital strength in the other segments. We've commented earlier in the year regarding the importance of property management. We're actually seeing some of our commercial repaint activity pick up as well, and the protective and marine has been fairly strong for the company throughout the year. The one segment, obviously, that remains a little bit of a lagger would be in that new residential area.

Sean P. Hennessy

Right. And when you look at the stores group, we were up 10.2% for the quarter, comp store growth about -- we were up 8.2%, Chuck. When you take a look at it, we feel pretty good about where we are with the selling prices. But as Chris mentioned, as some of the segments have changed, you're starting to see not a mix change by customer. Customers, they're not changing the mix, but because of that, it does change how much the average selling price will increase just because of different bases. But our selling price increases in the mid -- in that 5% to 7% -- 4% to 6% selling price increase in the quarter, then there's a little difference on the on the comp stores gallon gain.

Christopher M. Connor

And then just to conclude the question, Chuck, regarding the Global Finishes Group, all 3 segments that we report there, product finishes, vehicle refinish and the protective segment, all were very comparable and very nice solid gallon performance and the strong revenue that we already commented on.

Charles Edward Cerankosky - Northcoast Research

And just to go back to Paint Stores, so taking 4% to 6% away from the comp number gives us some comp volume growth?

Sean P. Hennessy

Yes.

Charles Edward Cerankosky - Northcoast Research

All right. And would you see that level of volume, similar level of volume growth in the Global Finishes segment?

Sean P. Hennessy

Yes.

Christopher M. Connor

At least.

Operator

Our next question is coming from Eugene Fedotoff with Longbow Research.

Eugene Fedotoff - Longbow Research LLC

Can you comment on the trends that you see in the markets and the global group, particularly in Brazil and Mexico? And also, if you can comment on the performance of your newly acquired businesses in Europe and your expectations for the businesses in fourth quarter.

Christopher M. Connor

Yes, I think we've talked about the Latin American market, where Brazil and Mexico reside. It's embedded in that Global Finishes Group, which, as we indicated, was at the high end of our sales performance of our 3 segments. And the Brazilian and Mexican businesses are very much in line with the kind of numbers that we commented on. I think regarding the acquisitions, specifically, we don't break them out individually. There was an earlier caller that asked us if we were on track around this $450 million impact, and we said we were. So I think, Eugene, these are all kind of performing on pro forma and as expected.

Eugene Fedotoff - Longbow Research LLC

Okay, great. And then on the price increases, Chris, you said that you announced 8% to 9% price increase in October. Just wondering if you're playing -- if this price increase is going to be enough to close the gap if raw materials and pricing cost start to stabilize here and there, too, may continue to increase? Or are you playing for additional price increases towards the end of the year or maybe early next year?

Christopher M. Connor

I think Sean commented earlier that we felt that by year-end, we would probably be in the range of the margin guidance that we've provided for a while now, in the 43% to 46% range. Historically, the company has operated at the peak of that range, and we're guiding that we'll probably be in the lower half of it. So that would indicate that we don't have all the pricing required to be back at the historic level. The company does not comment on perspective pricing actions, and we'll wait to see how the market responds on a number of fronts and give guidance to the street if and when we decide to take more pricing in the coming year.

Operator

Our next question is coming from Eric Bosshard with Cleveland Research Company.

Eric Bosshard - Cleveland Research Company

So first of all, on the volume front, I think the store volumes were down 2 or 3 points in the second quarter and up 3 points roughly in the third quarter. Can you just provide a little more color in terms of what changed and then also if this up 3% is kind of the new volume run rate we should assume as we head into 4Q and perhaps into '12? If you talk there, that would be great.

Sean P. Hennessy

Yes, Eric, I think just to remind everyone, last year, we felt that the government put a program out for new homebuyers that really pulled some sales forward. If you remember, and I'll remind everyone, March was very strong and April was very strong. May was very strong. And then you started to see the slippage in the third or fourth quarter. From our standpoint, we believe that the total year volume was probably not affected, but what happened was the timing of that, we had to go forward. This year, we are going against that. In the first and second quarter, we went through that and, as you said, really caused that decrease.

Having said that -- and we think that fourth quarter will look a lot like the third quarter. Having said that, when we talk about sequentially and so forth, we still feel pretty good about the second quarter volume in the stores group. Second to third quarter, we think that there was some increases there. But we think that just because of the major dramatic changes that that program caused in the second and third quarter last year caused major portion of the negative to positive.

Eric Bosshard - Cleveland Research Company

And then secondly, Sean, can you explain -- I understand how the consumer downtime hurt the margin in the third quarter. I guess I don't understand why you then produced more in the fourth quarter now that you've made this progress with inventory.

Christopher M. Connor

We don't.

Sean P. Hennessy

We don't. What happened -- once we've got our inventory down, you're not going to see it come down, but what happens is when your inventory comes up the balance sheet, your expensing that conversion in a different quarter than what you produced it, and that's what happens to us this year. And that's why I think that when you see the quarterly -- last year, our drop between the third and fourth quarter in the Consumer Group went from 17 down to 10. You're not going to see that same dramatic decrease of the 11.7 that we produced this third quarter.

Eric Bosshard - Cleveland Research Company

But that's on a sequential basis. On a year-over-year basis, it's going to look similar. It just won't drop sequentially. Is that the right way to think about it?

Sean P. Hennessy

Yes. I think that -- I usually don't do this, but I would tell you that the segment probably will have a higher operating margin in the fourth quarter, even with the raw material headwind.

Eric Bosshard - Cleveland Research Company

Why is that?

Sean P. Hennessy

Because of this drop that we took in the third quarter that won't repeat in the fourth.

Eric Bosshard - Cleveland Research Company

And then lastly, on gross margin, do you have visibility ability -- or how should we think about, understand the 43% to 46% range? At what point do we get to where we have stabilization in gross margin on a year-over-year basis?

Christopher M. Connor

So a lot of this, Eric, is obviously predicated on the raw material costing environment. So if you can answer that part of the formula [indiscernible], we'll tell you where we're going to stabilize. As you know, we're going to continue to put pricing into the market on the heels of raw material cost pressure to us, and so it's going to take some time for us to recover.

Operator

Our next question is coming from Dennis McGill with Zelman & Associates.

Dennis McGill

The first question, the effect of raw materials as we think about '12. Chris, I think you said we'll see -- kind of you're not sure where some of the forecasts go, but just given where cost and how cost plays in this year, if you just held sort of raw material cost constant, what would that sort of imply for the basket next year?

Christopher M. Connor

I think that, Dennis, to that point, if we were unable to freeze raw material cost right where they are today, we'd still see a mid-double-digit kind of price increase next year, in the teens.

Dennis McGill

A mid-double-digit increase on the raw materials side?

Christopher M. Connor

Yes.

Dennis McGill

Yes, okay. And then sort of separately, and I'm not sure how much you want to get into the details of kind of competitor actions, but realizing one of the home centers pushing more aggressively into the pro side or the paint [indiscernible] and seen increased presence of -- maybe going after your contractors. Can you just talk about how you guys think about that as a competitive threat, whether these are different types of contractors that might be doing multiple things as opposed to just paint or other ways to kind of frame that versus any other threat you usually see in the market?

Christopher M. Connor

Sure. Well, we have terrific respect for all the big-box competitors that are in this space. We have watched for decades, essentially, Dennis, and see the same demographic shift toward the paint that we've watching in a number of initiatives and programs that have been introduced to attract that customer into their footprint. It's incumbent upon Sherwin and the other operators of the specialty paint store chains to continue to do the things to keep that customer loyal to our channel. I think those actions are afoot. You see that simply as we continue to open more and more convenient store locations, as well as the caliber and the talent we put inside the store and the technology and the product that's being introduced.

So all those things continue to keep this customer loyal to the channel. Having said that, we think that these are very compelling competitors, and we have to continue to pay attention. You make reference to the more -- not so much the painting contractor, specifically, but more of the remodeling contractor or what we sometime refer to as the handyman, who might be buying multiple home improvement products, not just in the same category, and that's a more appropriate customer [indiscernible]. We think that's happening, and time will tell where these all shakes out. We remain committed to being the retail location and choice for the professional painting contractor, and we like our chances going forward.

Dennis McGill

And you said that you can measure volumes in the quarter at least holding share. Do you feel comfortable with that sort of 30% volume is similar to the market or better than the market?

Christopher M. Connor

Absolutely.

Operator

Our next question is coming from Kevin McCarthy with Bank of America Merrill Lynch.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

With regard to your protective and marine coatings business, can you advise us how that would split in terms of OEM versus repaint and also how protective per se versus marine? I would've thought you'd see a little volume pressure on the marine side, but it looks like it's netting out to positive.

Robert J. Wells

Yes, that's been a pretty solid category for us, Kevin. And as with the architectural business, the amount of new build -- or the degree to which new build is driving that category is way down. So normally, it could be as much as 20% of volume going into new build. We would suspect that in this environment, it would be close to half of that, maybe 10% to 12%. The repaint side, the recoat side is the piece of the business that's holding up quite well.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

How would it split, Bob, between protective and marine?

Robert J. Wells

The market, I'm not sure of the split in the market. In our business, we are skewed very heavily toward protective.

Kevin W. McCarthy - BofA Merrill Lynch, Research Division

Okay, great. And then, Sean, with regard to the board's new authorization of an additional 20 million shares to be repurchased, can you comment broadly on the expected pace of execution there relative to your old 30 million authorization put forth in October of '07? Is there any reason to believe it would be different over a multiyear period?

Sean P. Hennessy

I'm glad you mentioned that '07 because this 20 million is really not anything new to this management team. We also received 20 million in 2005 and 2003. So it's been an ongoing program. I think the way we've been purchasing the stock is pretty consistent to what you're going to see in the future. I think that it's not that we're always trying to do 4%. But it's interesting, when you look over the 10-year period, annually, it's been at least 4% every year. I think that, again, the cash we're producing, we're going to be looking for acquisitions or the dividends are important to us, the CapEx and, and where there are acquisitions, you're going to still see us buying stock. And as Chris mentioned, one time in -- 41 straight quarters, we've purchased stocks. So I think you'll still see us in the market every quarter.

Operator

Our next question is coming from Chris Nocella with Barclays Capital.

Christopher J. Nocella - Barclays Capital, Research Division

Just going back to the question on volumes. Given your architectural coatings you're managing for many years now, how do you think of the potential for pent-up demand given that people have delayed remodeling projects? So basically, do you see the potential for higher volume even if the housing market turnover specifically remains pretty depressed?

Christopher M. Connor

Yes, Chris, we have been commenting that the residential repaint market will be rebounding and, as Bob said, mainly on the maintenance side, and a good part of that is because of this pent-up demand. The number that I can maybe share with you that will give you some comfort around that is that we've been talking about the U.S. architectural coatings industry at its peak 4 years or so ago, produced 800 million gallons, and that number's dropped to just below 600 million gallons.

And if you back out the housing bubble impact, it had new home construction and new commercial construction kind of in more normalized historic run rates, not bubble rates. The industry should be somewhere in the 725 million to maybe as high as 750 million gallons. So we think that as the new construction comes back, it doesn't account for all that growth in 600 million to mid-700s. There's obviously pent-up demand on maintenance, both residential and some commercial as well, and I think that will be the strength of this market for the next several years.

Christopher J. Nocella - Barclays Capital, Research Division

Okay. And as those volumes improve, how do you think of the need to add cost in this environment?

Sean P. Hennessy

I'm sorry. I didn't really get the relationship there. Can you ask the question again, please?

Christopher J. Nocella - Barclays Capital, Research Division

Well, if you have improving volumes, your need to add SG&A costs?

Sean P. Hennessy

Yes. I think when you take a look at it, there will be some incremental, really, but I think that SG&A at this level, we think that over 90% is fixed. And the reason it's so high is that we consider manpower in the store being [indiscernible] is a fixed cost. You don't open a store without a manager, a system manager and the right staffing. So when we look at what we are able to do between 2002 and 2007 and look at the incremental -- how much we brought down to the bottom line and incremental income, we think that we could actually be slightly higher than that if it goes back up to that 725 million to 750 million range. And we think our capacity -- where we're running that capacity gives us some nice incremental flow-through.

Operator

Our next question is coming from Jeremy Brunelli with Consumer Edge Research.

Jeremy Brunelli

This year, we've had an unprecedented number of major weather events, Hurricane Irene, most recently, the tornadoes Midwest, et cetera. Do you have any sense of the acceleration in volumes and maybe paint projects in your domestic market, whether they have anything to do with these weather events? And then just a second question, when you look at kind of the repaint in architectural demand, is any sense that there is an increase in average project size or total number of projects that you're getting maybe from the survey work that you do at the Paint Store level?

Christopher M. Connor

Jeremy, first comment on the weather, I think that yes, Irene certainly impacted up and down the eastern seaboard, but as a country, we think some form of hurricane weather activity. Every year, we take various rains and snow storms, et cetera, so it's rare that the company comments on weather having either a negative or positive impact on the organization. We have seen from time to time geographically some impacts on these, but Irene has been the caliber hurricane that would have done that. Katrina moved the needle for us in the southwestern part of the United States. Various other hurricanes historically in Florida might have, but I don't think that those things will move the needle or having an impact in the third quarter volumes that we've been talking about. In terms of the repaint projects we're seeing relative to average size or scope, I don't think there's a lot of change in that at all.

Robert J. Wells

The only thing I'd say on that, Jeremy, is that given that residential repaint has been where most of the strength in the market has been over the last few quarters, those tend to be smaller projects than the commercial projects. So if we see a meaningful rebound in commercial volume, that probably suggests larger product size.

Jeremy Brunelli

And do you have any sense that whether these are kind of projects that are done jointly with other parts of the projects, so maybe like a kitchen remodel, or are these projects mostly focused around just doing a paint project and that's it, no other aspects of the project?

Robert J. Wells

Well, given that large-ticket home improvement projects are down, I would say that the growth we're seeing in the residential repaint market, which has been modest, but it's been positive, are likely maintenance painting projects and redecorating projects as opposed to the tailwind of large capital improvement projects.

Operator

Our next question is coming from the line of Silke Kueck with JPMorgan.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

On average, the volume growth on mature wins looks higher than what's reported by some of your global competitors. Can you talk about, like, where you may have gained share?

Christopher M. Connor

Yes, I think, Silke, that clearly in the painting contractor segments that we've been talking about, we're pretty confident that this has been the share-gaining cycle that we've been through in the third quarter. We'll confirm that as well. I think our DIY performance through our stores group also has been a share-gaining performance. It's been performing right in line with these high revenue numbers that we've been commenting on through the stores, and the volume performance has been nice there as well, too.

Obviously, we have commented publicly about our Consumer Group's loss of a significant retail partner, so I think all in, when you look at the DIY segment, the puts and takes are probably more in the flattish area. But clearly, again these professional painting contractors across all the segments, will continue to gain share.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

And then in terms of raw material costs, I think you earlier said that if raw materials stayed flat where they are today, they would be up low or mid-double digits in 2012. And does that factor in any decreases in propylene cost? Because when you look at any of the projections for propylene cost, one would think that eventually, your quoted cost would be down double-digit if stay where they are today.

Christopher M. Connor

Yes, we don't disagree with that. But I think the question was if the raw material costs, to us, stayed consistent, where would our overall input cost be throughout calendar 2012, and that was the comment that we'd be in the low to mid-teens. If propylene turns over and we start to see that feedstock pricing comes through our raws here, this thesis is correct.

Silke Kueck-Valdes - JP Morgan Chase & Co, Research Division

What's normally -- I mean, anybody can look at propylene prices, so if you look at what propylene price is doing, how long it takes the quoted prices to change?

Sean P. Hennessy

Yes, we should be seeing the drop in propylene flowing through that portion of the raw material basket in the next quarter or 2.

Operator

Our next question is coming from the line of Gregg Goodnight with UBS.

Gregg A. Goodnight - UBS Investment Bank, Research Division

Would you comment on -- price aside, would you comment on TiO2 availability in inventories you're seeing out there both now and your commitments for sourcing TiO2 for the important 2012? Do you see any issues there?

Christopher M. Connor

We've got no issues with that at all, Greg. Supply is fine for this year as well as the foreseeable future.

Gregg A. Goodnight - UBS Investment Bank, Research Division

Okay. And in terms of inventories and availability, are things fairly balanced?

Christopher M. Connor

In terms of our inventory?

Gregg A. Goodnight - UBS Investment Bank, Research Division

Yes, well, your reading on the industry.

Christopher M. Connor

Yes, I think we're fine. I don't hear any stress in the industry where we're unable to get inventory on raw materials.

Gregg A. Goodnight - UBS Investment Bank, Research Division

Okay. Second question. Bob, in terms of lead paint, is the Gaines case the final battle there, or do we -- is that the last chapter on lead paint?

Robert J. Wells

There are a handful of personal injury suits still pending, Gregg. I think we have one maybe in Mississippi and a couple in Wisconsin. There is also the matter of the public nuisance complaint still pending in California, which we are in a discovery phase now. And it's slated to go to trial late next year, but we'll see if we stick to that timing.

Gregg A. Goodnight - UBS Investment Bank, Research Division

Okay, great. Sean, TiO2 year-over-year increases, what percentage of your year-over-year, total year-over-year raw material increase did the TiO2 contribute?

Sean P. Hennessy

Yes. I think most of the time we do talk about the basket. We still believe that the basket will increase in the high teens, low 20% range. When you take a look at that, the majority of it is that titanium dioxide.

Gregg A. Goodnight - UBS Investment Bank, Research Division

Okay. Last question, if I could. The experts are talking about TiO2 price increases switching from a TiO2-constrained to an ore-constrained situation. In fact, they are talking about retail prices averaging $720 a ton this year going up to $2,000 a ton by 2013. My question to you guys is: Have you looked at the ore situation? Do you believe the ore prices could potentially fly up by a factor of 2 or 3 for the high-grade ores?

Christopher M. Connor

Yes, Greg, we are aware of the orefication, I would say, for the first time probably in 3 or 4 of these titanium runs that I've been involved in. We've actually been a little bit more work through, the providers of TiO2 to the ore manufacturer. So we are marginally up to speed on some of the economics that are facing that. I don't think we really have an opinion or comment on that at this point in time.

Operator

Our next question is from Don Carson with Susquehanna Financial.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

First question is just on your guidance. I mean, the $0.67 to $0.87 is a pretty wide range for the fourth week in October. Just wondering what put you at the top, what put you at bottom. And I know you had an improvement in volumes this quarter, but obviously, you're coming out of some tough comps in the first half. So is it volume upside you see? Is it just something breaking on price realization going through quicker than expected? Just what drives that wide range so late in the year.

Sean P. Hennessy

Yes, Don, really just one factor, and you're very accurate. We feel pretty good where we think the sales will come in, what we think is going to happen with the SG&A, what we think our interest expense and so forth will be.

It really comes down to this cost thing and how much cost will come in and the effect on our LIFO reserves for the year. That's probably the #1 reason that the range is -- the range, without that volatility in the gross margin -- really caused by the 2 things. We'll see what our costs of goods sold are in the fourth quarter. And as you know, with LIFO, that's last in, first out, so we'll see what happens. And then the LIFO reserve as well as the raws are causing that.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And then a follow-up on the Consumer Group, I guess you're close to lapping the loss of color plates business. Was that much of a volume for you in the fourth quarter of last year? Because I guess at that time, you knew that that would running off anyway. So was that part of the improvement in consumer margins as well as the comps get a little easier?

Sean P. Hennessy

Not actually in the fourth quarter. Fourth quarter was still a fairly strong quarter for us, not only for the color plates that we were providing, but if any of the other 3 vendors had any type of issues as far as providing, we were doing the providing for their product. So fourth quarter was still a pretty good quarter for us with that Walmart business. Really, in the fourth quarter, you're going to see the annualization.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And, Chris, you've talked in the past about the potential for, perhaps, becoming a second source of supply to one of the big-boxes. Any progress there? I know in the past, there's been hang-ups over branding and things like that, but is there any update you can provide us there?

Christopher M. Connor

No, nothing to comment on that at this time, Don.

Donald Carson - Susquehanna Financial Group, LLLP, Research Division

And then final question, you talked about how you've gained share. Is that a case of your gaining work of a contractor business, or do you think that this contractor versus big-box dynamic has sort of played out? And as you've said, some of the handyman and remodelers who buy from big-boxes, that's taken some share of the contractor market. So I'm just wondering whether these were just market share gains that you had or whether it's an improvement in the overall contractor big-box?

Christopher M. Connor

Yes, we talked publicly about the split in the market between the contractor, painting contractor purchases and all other categories, which would include DIY, primarily, but also some of this remodeler. Anybody that doesn't generate more of than 75% of their revenue from applying paint, we don't consider a painting contractor. That shift has moderated at 55% of all purchases for painting contractors. It's the second year in a row. So after seeing it fall for a couple of years due to the falloff in construction, that's moderating.

Relative to the shift between that and the big-boxes, we haven't seen any movement from the contractor toward the big-boxes. So the share gains that we're speaking of -- and when we talk about share, we're going into the individual segment, have we gained more share specifically against the res repaint contractor, the commercial contractor, et cetera. And that's where we told you that we're quite confident that this has been a share-gaining cycle for us against all those subsegments.

Operator

Our next question is coming from the line of Nils Wallin with CLSA.

Nils-Bertil Wallin - CLSA Asia-Pacific Markets, Research Division

Just on a little bit further detail on the share gains. I'm just trying understand what you would see is driving that. Is this better quality, better service that you're seeing people shifting away from competitors, or is it -- would you qualify as competitors kind of saying, "We just can't really maintain the business as it is. We don't have the control distribution. It just doesn't makes sense for us." or they're leaving the marketplace?

Christopher M. Connor

Yes, again, speaking specifically about the painting contractor market in North America and their strong preference for the specialty paint store channel, we think during this cycle that we've seen north of a thousand locations close. That would be a small mom-and-pop, independent dealer, as well as some of the larger national and regional chains that we compete with in close locations.

So just on a door count alone, the share position has improved. I think when you look inside that -- in each of our calls over the last several quarters, we've talked about the strategic decision the company's made to keep staffing levels in these stores at high levels. That's why our SG&A peaked, and I think, again, that's the key component of keeping contractors loyal to that footprint. So all those things would be part and parcel of why that share shift is moving towards the Sherwin-Williams store footprint.

Nils-Bertil Wallin - Credit Agricole Securities (USA) Inc., Research Division

Got it. And then with regard to overall pricing mix, next year, you said, of course, that raw materials, seeing them up even if they stayed flat in the teens. Is there any way, even as you try to get to price increases just on the raw materials side, to improve your mix so that overall, whether or not you recover your raws, you're still getting stronger pricing?

Sean P. Hennessy

Over the course of time and through all of these, usually, we do see us a positive mix change for us on the gross margin side, as well as the -- towards the higher quality products. And then with new products, that, again, occurs. So I think that next year, we're going to be more of the same. I think we're going to see positive mix for us in 2012. And as Chris said, when you annualize where we're at just currently, you do have a raw material increase. And with the pricing that we did in October, that's going to be annualized next October. I think you're going to see price still be a good size factor for increasing sales next year.

Operator

Our next question is coming from Ivan Marcuse with KeyBanc Capital Markets.

Ivan Marcuse - KeyBanc Capital Markets Inc., Research Division

Just a quick question. On the consumer side, do you expect the same production trends next year, so meaning a buildup of inventory in the first half and then working it off in the second half, or do you expect to continue or go back to where it's been historically?

Sean P. Hennessy

Yes. I think right now, we're going through that planning process, and it really has to come down to what we think is going to happen to raws and so forth. But I would tell you, it's probably -- even if we repeated it, it would not be as dramatic as it is in 2011. Will we be all the way back to where we were in 2009? I don't know, but we're finalizing those plans right now, but I don't think it'll be as dramatic as this year.

Operator

Our last question is a follow-up from Chuck Cerankosky with North Coast Research.

Charles Edward Cerankosky - Northcoast Research

Sean, I'm looking forward, too, to 2012 about the Consumer Group. I'm just trying to get a little more input from you with the complete cycling of the business decline at Walmart and maybe a new production cycle at the Consumer Group in 2012. What should we be thinking about in terms of sales increase and the cadence of the margin shifts year-over-year?

Sean P. Hennessy

Yes, I think that over time, we've talked about long term. We think it's going to be flat, up slightly. I think that when you take a look at the Consumer Group right now, probably, it's going to have a little more price than normal in next year, but I would say with a more normalized production rate. I think you're going to -- that's what I would say. In the near-term, you're going to see from consumer.

Charles Edward Cerankosky - Northcoast Research

Would you expect year-over-year margin improvements in consumer?

Sean P. Hennessy

In 2012, yes.

Charles Edward Cerankosky - Northcoast Research

Yes, versus '11?

Sean P. Hennessy

We're working on that game plan right now, but just as company, I think we expect margin improvement. Right now, we haven't finalized the plan, but I would say that our operating team, I don't think we'd come up here without a margin improvement next year.

Operator

Gentlemen, there are no further questions at this time. I'll now turn the floor back over to Bob Wells for closing comments.

Robert J. Wells

We'd like to thank you, all, for your participation on the call this morning, on this very busy reporting day for you. As always, I will be available over the balance of the day and week to take your follow-up questions. We appreciate you joining us this morning, and thanks for your continued interest in Sherwin-Williams.

Operator

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.

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