Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Sherwin-Williams Co. (NYSE:SHW)

Q3 2007 Earnings Call

October 23, 2007 11:00 am ET

Executives

Chris Connor - Chairman and Chief Executive Officer

Shaun Hennessy - Senior Vice President of Finance and Chief Financial Officer

John Ault - Vice President and Corporate Controller

Bob Wells - Vice President Corporate Communications

Analysts

Armando Lopez - Morgan Stanley

Anthony Petaneri - CitiGroup

Eric Bosshard - Cleveland Research Company

Peter Thompson - Coho Partners

Chuck Cerankosky - FTN Midwest

Jeff Zekauskas - JPMorgan

Saul Ludwig - KeyBanc

Greg Goodney - UBS

Tim Isaac - Bear Stearns

Robert Follis - Gabelli & Company

Operator

Good morning. Thank you for joining the Sherwin-Williams Company's review of the Third Quarter 2007 Financial Results and expectations for the Fourth Quarter and Full Year.

With us on today's call are Chris Connor, Chairman and CEO. Shaun Hennessy, Senior VP, Finance and CFO. John Ault, Vice President and Corporate Controller and Bob Wells, Vice President Corporate Communications.

The company has provided information regarding the third quarter and first nine months financial results. Business segments sales and profits, balance sheet items and selected statistical data an their website, www.sherwin.com, under Investor Relations third quarter press release. Please access this to supplement comments made on this call.

This conference call will include certain forward-looking statement as defined under U.S. Federal Security 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 takes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

A further declaration regarding forward-looking statements is provided in the company's release transmitted earlier this morning. This call is being webcast simultaneously in listen-only mode via the Internet at www.sherwin.com.

An archive replay of this webcast will be available approximately two hours after this conference call concludes. It can be accessed at www.sherwin.com and will be available until Friday November 9th, 2007 at 5:00 p.m. Eastern Time. After the company's opening remarks we will open this session to questions.

I will now turn the call over to Bob Wells.

Bob Wells

Thank you, Joe. I'll begin by summarizing overall company performance for 2007 versus third quarter 2006. Consolidated net sales increased 3.8%, $2.2 billion. Primarily due to acquisitions, strong domestic paint sales to commercial and industrial maintenance markets and strong international paint sales.

During the third quarter, we completed four acquisitions, which combined with M.A. Bruder & Sons and Nitco Paints acquired earlier increased third quarter consolidated sales by 2%.

Consolidated gross profit increased by $52.6 million for the quarter to $988.4 million and gross margin increased 80 basis points to 45% of sales. Selling, general, and administrative expenses decreased slightly to 30.5% of sales in the quarter to 30.7% last year, due primarily to tight spending controls.

For the quarter, interest expense, net of interest and investment income was $15.2 million compared to $10.3 million last year due primarily to an increase in debt during the quarter.

Consolidated profit before taxes for the third quarter increased $17.6 million or 6.4% to $294.3 million. This improvement was achieved despite a net increase of $13 million in net interest expense and other general and other expense net from higher environmental provisions and currency-related losses that were partially offset by increased gains on the sale of assets during the quarter.

Our tax rate for the quarter was 31.9% compared to 35.3% in the third quarter of '06. We expect our effective tax rate for the full year to be slightly higher than our year-to-date 2007 rate of 32.4%.

Consolidated net income for the quarter increased by $21.2 million or 11.9% to $200.4 million. Net income as a percent of sales improved to 9.1% in the third quarter this year from 8.5% last year due primarily to improved operations.

Diluted net income per common share for the quarter increased 19.2% to $1.55 per share compared to $1.30 per share in the third quarter 2006. Acquisitions reduced diluted net income per common share for the quarter by $0.02 cents per share.

Looking at our results by operating segment. Sales for our paint stores group increased 3.9% to $1.4 billion in third quarter 2007. Comparable store sales, that is sales by stores opened more than 12 calendar months were essentially flat in the quarter, compared to third quarter last year.

During the quarter Paint Stores segment completed the acquisition of Columbia Paint & Coatings, a 41-store chain of specialty Paint Stores in Spokane and Washington. The acquisition combined with M. A. Bruder acquired earlier in the year, increased Paint Stores Group sales by 2.7% in the quarter.

In addition to the growth from acquisitions, we saw some improvement in domestic architectural Paint sales to do it yourself customers and residential repaint contractors and continued strong commercial and industrial maintenance product sales. Regionally in the third quarter, our Mid Western Division lead the sales performance followed by Eastern, Southwestern and Southeastern. All four divisions achieved stronger sales results in the quarter compared to a year ago.

Segment profit for the group increased 9.6% to $248.4 million for the quarter. Operating margin increased to 17.7% from 16.8% last year due primarily to tight expense control and gross margins recovering to a more normalized rate. In the consumer group for the third quarter 2007, sales declined $5.5 million a reduction of 1.6% to $349.4 million.

This was due primarily to continued soft DIY demand at most of the group's retail customers. During the quarter, Consumer Group completed the acquisition of VHT, a line of high temperature coatings and premium aerosol products.

This acquisition had no affect on segment sales or profits in the quarter. Consumer segment profit increased $3.9 million or 6.4% to $64.1 million in the quarter. Segment profit as a percent of net external sales increased to 18.4% from 17% in the quarter last year primarily due to tight spending control and improved manufacturing direct conversion cost.

Turning to our global group for the third quarter '07, net sales in U.S. dollars increased $32.9 million or 8% to $444.9 million. Stated in local currency, sales grew by 4.5% in the quarter due primarily to architectural and automotive paint volume gains in South America and improved product finishes sales in most markets.

The second quarter acquisition of Nitco Paints and the third quarter acquisitions of Napco, a protective coatings company based in Mexico and Panturist Industrially (ph) a paint company in Europe, increased global segment net sales in U.S. dollar by 1.6% in the quarter.

Segment profit for the global group increased $5.3 million or 12.4% to $48 million in the quarter. Segment profit as a percent of net sales improved to 10.8% from 10.4% last year. This improvement was mostly attributable to increased sales, improving operating efficiencies related to additional manufacturing volume, and expense control.

I'd now like to comment briefly on some of our balance sheet items. Our total debt on September 30th, 2007, was $960.7 million. Short-term borrowing increased $380.6 million to $656.4 million compared to third quarter last year.

Total borrowings to capitalization were 34.2% at the end of the quarter versus 27.5% at the end of third quarter 2006. Long-term debt to capitalization was 14.2% at the end of the third quarter this year compared to 19.7% last year.

Our cash balance at September 30, 2007, was $21.2 million compared to $400.4 million in 2006. Over the past year we have used this cash and the increase in short-term borrowings to retire $200 million in long-term debt, fund acquisitions, purchase treasury stock and provide seasonal working capital. During the third quarter the company acquired 5.55 million shares of its common stock on the open market.

In the third quarter 2007, we spent $33.9 million on capital expenditures; depreciation expense was $35.5 million and amortization expense was $6 million. For the full year 2007, capital expenditures will be approximately $160 million below our earlier estimate of approximately $180 million.

A significant share of these capital expenditures will go toward investing in new stores, additional plant capacity and continued spending to upgrade our manufacturing facilities and replace plant and store equipment as necessary.

Depreciation will be about $130 million for the year versus $123 million in 2006. An amortization will be $24 million versus $23 million in 2006. I'll conclude this review with a brief update on the status of our led litigation. In Rhode Island, the defendants appeal to the Rhode Islands Supreme Court is progressing slowly.

The transcript of the lower court trial was delivered to the Supreme Court and a scheduling conference should take place in the near future to determine when briefs will be filed and when oral arguments will be heard.

In the abatement proceeding, the lower court judge has elected to interview potential candidates for the position of special master. We expect these interviews to occur in the coming weeks. In Ohio, all of the remaining lawsuits are now active and motions to dismiss have been filed.

You might recall from our second quarter comments that three of the eight remaining Ohio municipal suits had been stayed along with the attorney general's suit pending the state's Supreme Courts ruling on senate bill 117, a bill designed to clarify Ohio's product liability law.

The Supreme Court upheld the validity of senate bill 117, but gave opponents of the bill until November 1st to gather the signatures needed to put a recall referendum on the 2008 ballot. The stay in the city of Columbus attorney general suit has been lifted, and that case will begin moving forward. A motion to dismiss will be the first issue to face the court.

In Wisconsin, the Thomas case, a single plaintiff suit brought on behalf of a minor child is in trial the plaintiff has concluded its case and the defendants have just begun putting theirs on. The trial is expected to re-conclude in early November.

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

Chris Connor

Thanks, Bob and good morning everybody. Thanks for joining us today. The third quarter of ‘07 was a solid quarter for the Sherwin-Williams Company in many ways. We generated record sales, earnings and cash flow for the quarter. We completed four important acquisitions as Bob mentioned. We continued to expand our controlled distribution platform domestically as well as abroad, and we purchased 5.5 million shares of our stock.

We’re pleased by to the improvements and consolidated net income and earnings per share performance that we’ve reported for the quarter, up 12% and 19% respectfully. This morning, however, I want to take a few minutes to highlight the profit performance of our operating segments during the quarter. Because I think, this clearly demonstrates the underlying strength of our business model and the earnings power of our company.

Combined segment profit for our three reportable segments increased by almost $31 million more than 9%, and the sales improvement of 3.8%. Sales from acquisitions, which were slightly diluted earnings contributed 2% of our total 3.8% increase in consolidated sales.

Clearly our operating segments are hitting their stride in terms of managing expenses and maximizing our profit flow through. All three segments posted strong operating margin increases for the quarter and we recovered an additional 80 basis points of consolidated gross margin. We still anticipate our consolidated gross margin for the year will be up more than 100 basis points over last year.

Importantly, the hard work our operating segments have done to improve our profitability has come at the same time that we've continued to invest in strengthening our capacity for future growth.

During the third quarter, our paint store segment opened 29 net new stores and added 41 new stores through the acquisition of Columbia paint and coatings. During the first nine months of 2007, paint stores group opened 59 net new stores and acquired 172 for a total increase in store count of 231 stores.

Our commitment to control distribution extends beyond North America. Our global group also opened seven new stores and branches during the quarter. And that brings our total year-to-date 26 new facilities.

We continue to make progress in our management of working capital as well from the third quarter, although our working capital ratio, accounts receivable, plus inventories, less payable, for 12 month sales, increased to 14.4% for the quarter compared to 13.1% for the third quarter of 2006.

The acquisitions of M.A. Bruder, Columbia paints, Nitco paints, Natco in to us account for this increase. Year-to-date we've generated $563.6 million in cash from operations compared to $537 million for the same period last year, an increase of more than $26 million in that operating cash.

As I mentioned at the beginning of my remarks, one of the ways we've been using our cash is to purchase our stock on the open market. Year-to-date we've purchased over $10 million shares.

On September 30, 2007, we had remaining authorization to purchase approximately $2.6 million shares of the company stock. On Friday October 19th, our Board of Directors cancelled this remaining authorization and approved a new share repurchase authorization for 30 million shares.

This action by the Board prepares management to maintain our consistent, long-standing practice of being an opportunistic buyer of our stock on the open market in the years to come.

Also at this meeting, our Board declared a regularly quarterly dividend of $0.315 per share compared to $0.25 last year continuing once again our long-standing record of paying out 30% of prior year's earnings per share and marking our 29th consecutive year of increased dividends.

Looking ahead we expect our consolidated net sales for the fourth quarter to increase 5 to 6% over the fourth quarter of 2006. For the full year 2007, we expect sales to increase in the low single-digits over 2006.

Based on that level of annual sales growth, we have raised our expectations for diluted net income for common share for the year to a range of $4.70 to $4.75 per share compared to $4.19 per share last year.

This change in our outlook for the year is a reflex in both of strength of our results in the first nine months and our confidence that we are well positioned to manage through the challenges that lie ahead in the fourth quarter and beyond.

Planning for 2008 is currently in progress and we will be prepared to provide you with sales and earnings expectations for next year during our year-end 2007 conference call.

Again, I'd like to thank all of you for joining us this morning, and now we'd be happy to open the lines for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Armando Lopez with Morgan Stanley. Please go ahead with your question.

Armando Lopez - Morgan Stanley

Hi, good morning everyone.

Chris Connor

Good morning Armando.

Armando Lopez - Morgan Stanley

Just a couple of quick questions, I guess first on the CapEx coming in lower than expected, could you maybe just talk a little bit more about what the variance around that is?

And then second, in terms of the full year guidance of $4.70 to $4.75 that seems like it would imply $0.80 to $0.85 fourth quarter, which would suggest a slowdown in the margin acceleration from the second and third quarter, if you could just talk a little bit about that?

Chris Connor

Why don't I ask, Sean Hennessy to comment on our Cap Ex number. Sean.

Sean Hennessy

When you take a look at Cap Ex, Armando. We had a few projects that we were planning in land purchases that we've pushed out and on capacity and that's really the main reason why our Cap Ex is going to be a little lower this year.

Armando Lopez - Morgan Stanley

Okay. So will that show up, then, next year? Or is it just like postponing it a year?

Chris Connor

Yeah, I think, that is as we watch the volume as we take a look at those things. Eventually they will spend that money, but we don't think, we didn't want to spend the money before we really needed to.

Armando Lopez - Morgan Stanley

Okay.

Chris Connor

And on the margin compression, I guess, $80 to $85, we're seeing at $4.70 to $4.75. I think when you take a look at a lot of different things that are moving around in that quarter, I think our segments will be a little compressed in one or two of the segments. But I think, for the full year we're going to show nice margin improvement in the three segments.

Armando Lopez - Morgan Stanley

Okay. And then just one last one, in terms of the 30 million authorization for the buyback.

Chris Connor

Yes.

Armando Lopez - Morgan Stanley

Is there a timeframe that you're expecting to work through?

Chris Connor

No, I don't think so. As we’ve said, this is consistent with our practice. Two years ago we received 20 million authorization from the board, two years before that 20 million authorization. So this is just part of our normal policy using excess cash to be opportunistic in the market.

Armando Lopez - Morgan Stanley

Okay. Thanks a lot. Nice quarter, guys.

Chris Connor

Thanks Armando.

Operator

Thank you. The next question is from P.J. Juvekar with CitiGroup. Please state your question.

Anthony Petaneri - CitiGroup

Hi, this is Anthony standing in for P. J.

Chris Connor

Good morning, Anthony.

Anthony Petaneri - CitiGroup

Good morning. After looking at results from value spar and PPGX, so we've had a lot about residential weakness creeping into commercial construction and industrial order books. Could you comment on any deterioration or softness you're seeing on industrial end markets?

Chris Connor

Sure, we’ll be happy to. Our commercial and industrial activity held up well in the third quarter. Fairly consistent with the same buying levels that we've seen throughout the calendar year 2007. Kind of sales and earnings guidance that we've given for the fourth quarter assumes that same kind of market performance going into the fourth quarter.

We would comment that for the industry, in calendar year 2006, these commercial industrial markets were growing more robustly perhaps in the double-digit range. And they have slowed down in '07. You know, the industry forecasting, perhaps, even a little slower in '08.

But we continue to believe this will be a positive segment for our company and we expect to make progress here.

Anthony Petaneri - CitiGroup

Great. Great. And just following up, I mean, when you look at the industrial end markets, if you look at auto or marine are there sub-segments where you're seeing particular strength or particular weakness? Or is it…?

Chris Connor

Yeah. Anthony, I think that probably the strongest segment that we’re seeing is in industrial maintenance coatings. Not any particular end user segment, but in general the protective finishes for Steel And Concrete have been very strong.

Anthony Petaneri - CitiGroup

Okay. Great. Thanks, guys.

Operator

Thank you. The next question is from Eric Bosshard with Cleveland Research Company. Please state your question.

Eric Bosshard - Cleveland Research Company

Good morning.

Chris Connor

Good morning, Eric.

Eric Bosshard - Cleveland Research Company

Two questions. First of all, from a bigger picture perspective, because when you came into the year you talked, I guess relative to the beginning of the year you're going to end up earning $0.10 or $0.15 more on sales there probably 4 or 5 points lower than what you had planned coming into the year. Can you just explain, how you're making more money with weaker sales?

Chris Connor

Yeah. Eric, I think, part of the processes that we go through here with our management teams are to react to the markets environment that we face. And if you look at our SG&A expense.

Particularly, we're really proud of the job our team has done to get that in line to see a lot of this slowing come ahead of time and pulled in. And the margin performance has also been strong for the company.

Eric Bosshard - Cleveland Research Company

Within the gross margin performance, which you've done a good job on all year, is there anything you highlight that you've been able to accomplish within that year during the year to create that upside?

Chris Connor

Well, the two inputs to gross margin, both played a role here. First, pricing, and our ability through our controlled distribution platform to get the necessary pricing over time has been indicated over the last several years I think our team did a nice job, did well this year. And in the raw materials input cost while we think for the industry is going to be up again this year, year-over-year.

We would comment on our team's job in managing through that as best as possible. So, on both sides of that, we've been able to make some progress this year.

Eric Bosshard - Cleveland Research Company

And second question on the raw material issue. Clearly those (inaudible) in the last 30 or 60 days, the world is changing. Can you comment about what your expectation is in terms of the industry's raw material cost growth this year and sort of how you're thinking about positioning the business in light of that as we move towards 2008?

Chris Connor

Yeah. I think the raw material input for calendar '07 and the third quarter, we saw continued to go up probably another 1 to 2% for the industry. And I think we're moving our guidance up a little bit. We had talked about it being in the low single digits, maybe flat to up to 3%.

It's our opinion now that the industry would see around 2 to 4% raw material cost increase for this calendar year '08, it's a little early for us Eric, yet to give guidance or pulling all those numbers together and we'll be happy to comment on that on our first quarter call

Eric Bosshard - Cleveland Research Company

And then just last, you commented earlier about commercial, but can you talk about the momentum of the business, September, October, indicated a commercial may be a little slower. But are you seeing things get better, get worse, stay the same? Can you give us a little sense on it?

Chris Connor

No. Guidance were given for the quarter for sales in the mid single digit range, which will be slightly better than what we've been able to do this year. It's been built pretty much the way that our years come together with the Stars Group performing in the mid single digits and our global a little bit higher and our consumer segment flattish.

And the role that the commercial, industrial accounts are playing in that store's business particularly, have been consistent. So, I would say there's really no significant change in the direction of what we're seeing from our revenue.

Eric Bosshard - Cleveland Research Company

Okay. That's great. Thank you.

Operator

The next question is from Chuck Cerankosky with FTN Midwest Securities. Please state your question. I'm sorry; the question is from Peter Thompson with Coho Partners. Please state your questions

Peter Thompson - Coho Partners

I’m sorry. I just had a one quick one for you if it is possible. Can you say how much you spent on the 5.5 million shares you bought?

Chris Connor

Sure, Sean -- but in the …

Sean Hennessy

Yes, the average price was $67, spent approximately $360 million.

Peter Thompson - Coho Partners

Okay. Can I just ask you one strategic question just on your -- on the Global Group? Could you just comment on kind of where you guys, you’re thinking that's going over the like three to five years?

Chris Connor

Yeah, I think the Global Group will continue to be a strong driver for us. We have given guidance that we expect it to grow at a high single digit, low double digit over the foreseeable timeframe that you're referencing.

As you know, our strongest presence is in Latin America, and we've continued to add to that position with some of these smaller acquisitions we've commented on. And the company has shown an appetite to perhaps expand in some more of the growth markets with recent activities in China and India.

Peter Thompson - Coho Partners

Is auto still being a gain market?

Chris Connor

Our automotive business continues to focus on the after-market. And they are a significant part of that Global Group. They represent about a third of those segments, revenue and profits.

Peter Thompson - Coho Partners

Great. Thanks so much.

Operator

The next question is from Chuck Cerankosky with FTN Midwest. Please state your question.

Chuck Cerankosky - FTN Midwest

Good afternoon or good morning, everyone.

Chris Connor

Hi Chuck!

Chuck Cerankosky - FTN Midwest

Hey, Chris! One for you, before I’m going for Sean, and looking at the DIY demand trends. They seem to be better the stores in the quarter than in the consumer group, any particular reason for that?

Chris Connor

Not particularly. Our retailing partners from our consumer group pretty much across the Board were feeling some weakness out the door. I think that's been borne out by their comments and their calls and releases. Our store's business continues to really focus on the high-end DIY customer and able to make some marginal improvements there.

Chuck Cerankosky - FTN Midwest

So, it sounds like it might be consumer segmentation here, quality versus price.

Chris Connor

Yeah. I don't know that I'd go that far. These are particularly from our store standpoint; it's not a big segment of what happens there? Was just we had a good quarter.

Chuck Cerankosky - FTN Midwest

Okay. Sean, if we're looking at the $0.02 that acquisitions cost earnings in the quarter. How would you break that down that operating losses or financing costs offsetting out and profits from the acquired companies?

Sean Hennessy

I would say 100% operating. As, we have come through, we haven't completed our synergies and some of the expenses, we've had during the integration sales, but I would say it's 100 operations.

Chuck Cerankosky - FTN Midwest

When do you think that will flip into the positive?

Chris Connor

I think, second quarter, probably around second quarter of next year.

Chuck Cerankosky - FTN Midwest

So that will be more or less a slight drag until then?

Chris Connor

Yes.

Chuck Cerankosky - FTN Midwest

All right. Thank you. Great quarter.

Chris Connor

Thanks, Chuck.

Operator

Thank you. The next question is from Jeff Zekauskas with JPMorgan. Please state your question.

Jeff Zekauskas - JPMorgan

Hi, good morning.

Chris Connor

Good morning, Jeff.

Jeff Zekauskas - JPMorgan

This quarter our year sales grew about 30.8% and you're talking about 5 to 6% sales growth in the fourth quarter. Where is the acceleration coming? Where is the extra two percentage points of growth coming from and why?

Chris Connor

Well, I think, as we commented at the beginning of the year, Jeff. We knew, if the year went on, we have a little bit easier comparables so that’s playing somewhat of a role here given the fourth quarter then we had last year.

Beyond that, I think that, the strength that we've seen in particularly the paint stores group and global group continues to give us confidence that we're going to get these numbers.

Jeff Zekauskas - JPMorgan

How much was your gallon went up this quarter or for the year, excluding acquisitions?

Chris Connor

For the store's group, which is the best place for us to comment on gallons, we were negative low-single digits in the quarter on gallons. And that's been fairly consistent for the year.

Consumer with negative sales would have been a little bit more backwards in gallon performance in global group had a probably mid-single digit gallon volume improvement.

Jeff Zekauskas - JPMorgan

As first Rhode Island goes, so if it turns out that Rhode Island determines Sherwin-Williams share of abatement cost is I don't know, $800 million? Are we going to see an $800 million cash outflow at a point in time? Or is that not the way to look at it?

Chris Connor

That's way too early to make an assumption regarding, what this abatement, if it ever comes to that settlement will look like.

Jeff Zekauskas - JPMorgan

I mean, assuming that that were the number. Is that the way it would affect Sherwin-Williams funds flow statement that way or would it not?

Chris Connor

Well, the other issue that's unknown to us, at this time, Jeff, is what is the timing mechanism of what an abatement order might look like in the future. So, if that were spread over a ten-year period or a five-year period, if other parties were brought into it. I just think, it's very too speculative at this point to comment on that.

Jeff Zekauskas - JPMorgan

Lastly, in terms of raw materials, you spoke about the industry being up 2 to 4%. I don’t know, it looked like TiO2 prices were down about 10% and even acrylics were probably down in the first half as well.

Do you think, raw materials are not really moving up that fast? Or how do you get 2 to 4% increase?

Chris Connor

Jeff, maybe you would like to accept the position as our Chief raw materials procurement agent, if you see a price like that.

Jeff Zekauskas - JPMorgan

That's terrific.

Chris Connor

There is a lot of different components that go into the basket of raw’s. And certainly, we've seen a pressure this year on the oil derivatives products, their packaging costs, demand for natural gas and energy components wherever that factors through has created some input.

So all in, this is the trend that we've been seeing all year. And as we've gone in the fourth quarter with oil up over into the mid and high 80s and even bumping against 90, this is what, we think is going to happen.

Jeff Zekauskas - JPMorgan

Okay. Thank you very much.

Operator

Thank you. The next question is from Saul Ludwig with KeyBanc. Please state your question.

Saul Ludwig - KeyBanc

All right. Good morning, guys.

Chris Connor

Good morning, Saul.

Saul Ludwig - KeyBanc

A lot of companies are complaining about distribution cost and high fuel costs. How bigger deal is that as you ship this heavy material all over the country?

Chris Connor

Well, Saul. A couple of things. It has negatively affected us and it has increased our cost of goods sold. We've put it through and you can see, what happened to our margin. But, also the last couple of years we've hedged our gasoline purchases for our fleet.

And those hedges have really helped us in the last -- in the first three quarters of this year.

Saul Ludwig - KeyBanc

Is this going to be a problem going forward as your hedges roll over?

Chris Connor

No, because we've layered them. We have layers and we have some that go out timing wise very well for us.

Saul Ludwig - KeyBanc

Okay. Great. How much did you spend for acquisitions in the third quarter?

Sean Hennessy

We spent $99 million in the third quarter and make us year-to-date $248 million year-to-date.

Saul Ludwig - KeyBanc

How do these businesses lose money? When you don't have to amortize any goodwill, you must to have paid some enormous multiple of EBITDA for them to be diluted. I'm just trying to figure out how you’re actually have dilution on an acquisition these days?

Sean Hennessy

Well, I think, Saul, when you sit there and take a look at taking care of the customer first, I think that both -- one of this -- one major acquisition we did this year was, I'd say, tight on SG&A at the store level and taking care of it. Just with timing, putting in some SG&A and so forth. But in the long run, it will be creative in the first full year we have it.

Saul Ludwig - KeyBanc

Okay. Sean, I can't help but ask about the administrative cost line. We'd be disappointed if you didn't.

Sean Hennessy

Saul, I'll tell you right now, if you will take a look at it, if you take a look at the line for the quarter we're at $66 million versus $53, which is up about $53 million. Really, let me tell you three factors that caused that to be a little higher than last year.

We had a $12.5 million environmental provision we took in the quarter. So, that was in that. Our interest expense was up about $4.7 million. That's a little over $17 million. We also sold an asset. We sold the third jet that we have, and we had a $6 million gain. So, when you put those three together between the interest and the environmental and the jet, it's about $11 million hit.

Saul Ludwig - KeyBanc

You had another $5million gain. Did you have an $11 million gain on asset of that?

Sean Hennessy

Right, $5million was in the store's operating segment of there was a piece of property from one of the acquisitions we've done a few years ago and so that other gain was in the store's operating segment.

Saul Ludwig - KeyBanc

Oh, that wasn't down in other income?

Sean Hennessy

No, it wasn't?

Saul Ludwig - KeyBanc

Within the in the stores so that side of margin of the stores to some degree.

Sean Hennessy

Yes. That helped the margin in the stores, yes.

Saul Ludwig - KeyBanc

Okay. And as we look to the fourth quarter, do we see administrative flattening out?

Sean Hennessy

Yes. I think you're going to see flattening out year-to-date, when you take a look at the $31 million, I know last year-to-date I talked about benefits costing $14 million and environmental and interest expense. But For the full year we do see that flattening out (inaudible) For the fourth quarter, not the full year? Yes, the fourth quarter…

Saul Ludwig - KeyBanc

All Right. Then also last year in the fourth quarter you had only a 22% tax rate. You also had a $16 million legal expense settlement, which I assume won't reappear. But the tax rate, is this part of the reason in this year looking for 33% tax rate, last year a 22% tax rate. Is that an issue in the lower rate of earnings per share growth?

Sean Hennessy

Yes. If you take a look at it for the full year and this quarter, as Bob mentioned, our tax rate was in the 31 versus 35. In the first quarter it flipped the other way. For the full year we feel it will be marginally higher than last year. You're right, in the fourth quarter we're going to have to go over that 22% tax rate.

Saul Ludwig - KeyBanc

Was the $16 million legal expense that you had last year, was that fully taxed? I mean, you got a tax benefit on that?

Sean Hennessy

Not fully, but on the majority of it, yes.

Saul Ludwig - KeyBanc

Okay. And I guess, Chris, you say in the stores relative to the down 6% of comp store sales, it was write down 2 5% in volume, which would apply up 1.9% in price, something like that?

Sean Hennessy

Directly in that's close

Saul Ludwig - KeyBanc

Okay. Great. Thank you, guys.

Sean Hennessy

Thanks, Tom.

Operator

Your next is from Greg Goodney (ph) with UBS. Please state your question.

Greg Goodney - UBS

High, guys.

Chris Connor

Hi Greg.

Greg Goodney - UBS

The revenue for store on your acquisition is that part of the issue that the stores were slightly dilutive to earnings? Do you expect to get the revenues up to your average, which is, what about a 1.5 million bucks a store? And when would do you that?

Chris Connor

Yes. I don't think the revenue impact at the acquisitions was part of the operating losses Sean, was commenting on. Our expectations are that these stores will start to perform closer to our levels in every way. And it probably takes you around two to three years to get to that run rate.

Greg Goodney - UBS

Okay. How much of a GAAP is there now?

Chris Connor

We wouldn't comment on that.

Greg Goodney - UBS

Okay. Next question. What's next on the M&A front? Is that going to be it for a while or do you have more things planned?

Chris Connor

Of course we have more things planned. Time will tell whether we're successful with any of them.

Greg Goodney - UBS

So I shouldn't necessarily assume that M&A is going to minimal and that cash would be used exclusively for share buyback, then.

Chris Connor

I think you can expect us for the remainder of the year as well as into '08 and beyond we continue to use cash consistent with the way we have been and we can find a creative acquisitions kind of in the size range that we're doing, we're going to make them.

Greg Goodney - UBS

Okay. Thanks, guys.

Chris Connor

Thanks.

Operator

The next question is from Tim Isaac with Bear Stearns. Please state your question.

Tim Isaac - Bear Stearns

Yes. Hi, good afternoon. Thanks for the call.

Chris Connor

Hi, Tim.

Tim Isaac - Bear Stearns

Hi. I was wondering on the lawsuit or the trial and with Wisconsin (ph) that you mentioned its will probably be finished by November, is that can you just give us a little bit more background on what the potential outcomes – outcome for that could be in sort of the down sides now?

In other words, I guess if you lost, is that a punitive damage situation? Or is it a class action status?

You know and what would you need to appeal? Thank you.

Chris Connor

Well Tim, I can't comment prospectively on what the damages might be. The suit is a personal injury lawsuit and it is a minor child who allegedly was affected by ingesting led paint when he was a young child.

And Wisconsin has a somewhat unique interpretation by their Supreme Court pertaining to risk contribution theory of liability, which is why this suit is being was brought in Wisconsin but, it is not a class action suit. It is a loan (inaudible) and the pretty straightforward suit in terms of personal injury complaint.

Tim Isaac - Bear Stearns

Okay great and are they alleging a certain amount or is it kind of just is there like a dollar amount they are putting on at this point?

Chris Connor

I don't believe there is. The plaintiff already made a recovery against the property owner.

Tim Isaac - Bear Stearns

Okay.

Chris Connor

Okay so it is time to go after somewhat you're saying?

Chris Connor

Yes.

Tim Isaac - Bear Stearns

Okay. Thank you very much. Congratulations on your quarter.

Chris Connor

Yes.

Operator

(Operator Instructions) Next question is from Robert Follis, Gabelli & Company. Please state your question.

Robert Follis - Gabelli & Company

Hi, guys. Most of my questions have been answered just a couple of quick ones. I guess first if I look at the operating income margins for the first three quarters really the highest level you see and

probably the last five, six, seven years.

So, just a couple of questions around that I guess firstly, how much of the improvement

this year would you attribute to I guess operating efficiencies, cost controls versus pricing above and beyond raw material cost inflation?

Chris Connor

I would tell you the we were completed, I wanted to jump in there to answer, but hopefully you completed your question. But when you sit there and take a look at our P&L and if you go right down to P&L, our margin is up 45 versus 44 year-to-date.

The margin expansion that we've had compared to last year is really first and foremost, that margin. Secondly as Chris mentioned earlier when Eric had that question, our SG&A is only up 4 times we've have been two straight quarters or SG&A as percent of sales went down.

When you think about the amount of new stores and acquisitions and so forth and so, that's really goes back to your efficiencies. And I think that for this year, margin is probably 60%, the efficiency is 40. If you look at the long-term and say, okay, now let's look over to five, six, seven years, our gross margin, that 45 year-to-date is back toward the high end of where we were four

years ago.

I'd say 90% of what the margin expansion has really been efficiencies and sales increases.

Robert Follis - Gabelli & Company

So, would you say that despite what could potentially be an up tick in raw materials as heading to the fourth quarter into 2008, that you'd be able to at least sustain current margins and then also, as you look as you look out over the next three or five years. What do you see as the ceiling for the margins?

Chris Connor

Yes, I think if you look at the short-term, and if we were to have a raw material increase in calendar year '08, if we were able to maintain margins, our history, Robert, would indicate that perhaps for a quarter or two or longer, depending on the severity of the increase, we see margin pressure. But over a period of time we're able to get pricing in the market and recover those margins.

And over a longer historical period, what we've done, as we've gone through each of these cycles, as we've come out of it, we've gotten back to our previous high watermark and then actually been able to make a little progress beyond that.

Kind of the way we think about running the company as we go forward is we would expect over time, with operating efficiencies and continued hard work that we can keep driving these margins perhaps 10 to 20 basis points a year so. There is no upward limit that we've ever established on what we can accomplish here.

Robert Follis - Gabelli & Company

Okay. So as I look to '08, perhaps some pressure, a little bit of pressure if raw tick up further. Hopefully you'll make that up as you go along.

Chris Connor

To you and all the listeners, when we next get together on the fourth quarter and full year conference call, which will be in the first quarter of '08, we'll give you all that thinking in terms of what we expect to happen to raws and how we'll manage to get through that.

Robert Follis - Gabelli & Company

Okay. And then I guess lastly, you've done a great job in the last three quarters controlling SG&A and bringing you down as a percent of sales. Is this sustainable? As we look forward, do you think you can maintain this level?

Chris Connor

Yeah. I think it's one of the hallmarks of the company. If you think about it, a significant portion of our SG&A resides in our store organization, with 3200 stores. So the ability to manage that, to flex it when necessary, and, again historically if you look back over periods, this has just been something the company has developed a habit and discipline in doing.

So, our expectation going forward is that we will be in that range. It may go backwards 10 to 20 basis points, in a given period. But over time and sustainable we would expect to be in that period or slightly better.

Robert Follis - Gabelli & Company

Okay. Thanks for the help.

Chris Connor

Thank you. The next question is from Saul Ludwig with KeyBanc. Please state your question.

Saul Ludwig - KeyBanc

Just a follow-up on this, the environmental costs which were so much in the third quarter. As we look to fourth quarter, I don't know, even internally how you guys budget that number, but you've got to think about it, I guess, and make a shot.

Last year you had $6 million in environmental cost in the fourth quarter, year before you had $12.5 million. How should we think about the fourth quarter, recognizing that it may be a mushy number?

Chris Connor

I think it will be lower than last year. Okay. Thank you very much.

Operator

I'm sorry, there are no questions in queue. I'd like to turn it back over to management for closing comments.

Chris Connor

Thank you, Joe. I will be available all afternoon to answer any follow-up questions you have. I look forward to taking your calls. And as always, we appreciate you joining us in this morning's call and thank you for your interest in Sherwin-Williams.

Operator

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Sherwin-Williams Q3 2007 Earnings Call Transcript
This Transcript
All Transcripts